Drivers for the Week Ahead

  • The US government will shut down Friday if Congress fails to pass an omnibus spending bill for the current FY21; expectations for a stimulus package are rising; weak jobs report Friday is likely adding to the sense of urgency for Congress
  • The major US data releases this week center around inflation; market appetite for UST issuance will be tested this week, with a near record $118 bln on offer; we believe the Fed is watching the yield curve closely; November budget statement Thursday will hold some interest
  • BOC meets Wednesday and is expected to keep policy unchanged; Brexit talks stalled ahead of the weekend but have since resumed; two-day EU summit begins Thursday; ECB meets Thursday and is expected to add more stimulus; UK has its monthly data dump Thursday
  • Japan reports some limited data this week; next BOJ meeting is December 17-18 and reports suggest it will extend its emergency programs then; Australia sounded a warning about the impact on trade of its diplomatic spat with China

Dollar weakness should resume.  DXY traded last week at the lowest level since April 2018 near 90.476 before Friday saw a bout of short-covering that helped boost the dollar ahead of the weekend. Dollar weakness should persist and so we continue to target the February 2018 low near 88.253.  The euro traded at a new cycle high near $1.2180 Friday and we maintain our medium-term target of $1.2555.  Sterling traded at a new high for this move near $1.3540 but gave up those gains due to rising Brexit concerns.  USD/JPY is trading on both sides of 104 but remains heavy and so we still look for a test of the November low near 103.20.

 

AMERICAS

The US government will shut down Friday if Congress fails to pass an omnibus spending bill for the current FY21. Our base case is that the bill will be passed and a shutdown avoided. Worst case, Congress passes another continuing resolution that punts the matter to the next Congress. There is always tail risk, of course. Outgoing President Trump could try to throw a spanner in the works with a veto of the key defense spending bill. However, House Majority Leader Hoyer said he has enough votes to override a veto, suggesting the spirit of bipartisanship is not quite dead. The defense bill has passed without fail for the last 59 years and we are heartened to hear that the streak is likely to continue.

Expectations for a stimulus package are rising.  House Speaker Pelosi sees momentum building for a compromise plan. Pelosi said she spoke with Senate Majority Leader McConnell about attaching stimulus measures to the omnibus spending bill. Still, it appears that aid to state and local governments remains a thorny issue. The proposed $908 bln compromise would give $160 bln to state and local governments, but Republicans seem resistant. Republican Senator Grassley said “If the figure’s over 150, I won’t like it.” Yet recent data suggest that the bailout is not going to be just for Blue States, as many Republicans claim. Many Red States are starting to experience serious budgetary shortfalls, which may help get a compromise done that helps ALL states.

The weak jobs report Friday is likely adding to the sense of urgency for Congress. The 245k gain was disappointing but not very surprising given rising virus numbers and widening lockdowns. This is the lowest job gain since January and 245k is a solid reading in pre-pandemic terms, it is clearly not good when tens of millions are still out of work. With the outlook clearly worsening, we think Congress is simply coming under greater pressure to do something. While the compromise package will be much smaller ($500-900 bln) than what many think is needed, something is better than nothing before year-end. Democrats can settle now with the hopes of getting another package in 2021, while Republicans can give its Georgia Senate candidates something positive to point to ahead of the January 5 runoffs.

The major US data releases this week center around inflation. November CPI will be reported Thursday. Headline inflation is expected to fall a tick to 1.1% y/y while core is expected to remain steady at 1.6% y/y, respectively. PPI will be reported Friday. Headline is expected to rise a couple of ticks to 0.7% y/y while core is expected to rise a few ticks to 1.5% y/y. Given the softening labor market, we simply cannot get too concerned about inflation risks. We believe wage pressures remain the single biggest factor behind broader price pressures and with nearly 10 mln jobs still lost and nearly 20 mln collecting unemployment benefits, those pressures are just not very likely near-term.

If there is little inflation in the pipeline, why were US yields higher after the disappointing jobs data? One theory is that the weak jobs number increases odds of a near-term stimulus. While we have sympathy for this argument, we’d stress again that the package is likely to be much smaller in scale than the numbers being tossed around previously. As such, the supply of UST isn’t likely to jump so much that the market can’t absorb it. This 0.98% level is key for the 10-year as a break above would set up a test of the March high near 1.27%.

Market appetite for UST issuance will be tested this week, with a near record $118 bln on offer. The US Treasury auctions $56 bln of 3-year notes Tuesday, followed by $38 bln of 10-year notes Wednesday and $24 bln of 30-year bonds Thursday. What’s noteworthy to us is that the recent rise in US rates has done the dollar no favors, and that is likely to continue.

We believe the Fed is watching the yield curve closely. A break above 1.0% would likely trigger some jawboning, while a break above 1.25% would likely trigger some action. The upcoming December 15-16 may provide some clues to the Fed’s thinking here. The media embargo is not in place and so we will get no Fed speakers until Chair Powell’s post-decision press conference next Wednesday.

The November budget statement Thursday will hold some interest. A deficit of -$199 bln is expected vs. -$284 bln in October. If so, the 12-month total would fall slightly to -$3.27 trln. Upward pressure on the deficit will be maintained next year. Not only will the next stimulus package add to outlays, but the sluggish recovery will weigh on receipts. The Congressional Budget Office’s most recent forecasts see a deficit of for FY21 and for FY22. We see upside risks to both numbers.

In light of the disappointing November jobs data, weekly jobless claims Thursday will be closely watched. Regular initial claims are expected at 725k vs. 712k the previous week, while regular continuing claims are expected at 5.27 mln vs. 5.52 mln the previous week. Despite the marginal improvements being seen here, it’s clear that the labor market remains under stress and it’s only getting worse as lockdowns widen and deepen.

The rest of the week is filled with mostly minor data. October consumer credit ($16.1 bln expected) will be reported Monday, followed by wholesale trade sales and inventories (0.9% m/m expected) and JOLTS jobs openings (6325 expected) Wednesday. Thursday brings November real earnings. Preliminary December University of Michigan consumer sentiment will be reported Friday, which is expected to fall to 76.0 from 76.9 in November.

Bank of Canada meets Wednesday and is expected to keep policy unchanged. The Loonie tends to gain on decision days. Of the nine held so far this year, it has weakened on only two of those days. For now, the bank is on hold as the emphasis is on fiscal stimulus. The Trudeau government just announced a new series of spending measures last week worth CAD25 bln in FY202O-21 and CAD27 bln in FY2021-22.  Finance Minister Freeland said the government plans to deliver additional stimulus of between CAD70-100 bln cumulatively over the next three years but did not provide further details as this additional stimulus is not in the fiscal framework.  Ahead of the decision, November Ivey PMI will be reported Monday. Last week’s jobs data was unequivocally strong but policymakers will remain on guard.

 

EUROPE/MIDDLE EAST/AFRICA

This is a very important week for the EU. Brexit talks have to wind up ahead of the EU summit that starts Thursday. Besides the thorny Brexit issue, the EU is still struggling to pass its long-term budget and recovery fund. For good measure, the ECB meets Thursday. Let’s take a look at each of these key events.

Brexit talks stalled ahead of the weekend but have since resumed. Negotiators from both sides said talks had been paused because “conditions for an agreement are not met” and while warning of “significant divergences” in the three main areas of disagreement: fisheries, level playing field, and enforcement. UK Prime Minister Johnson and EU President von der Leyen spoke Saturday and appear to have broken the logjam again, with talks resuming Sunday. Quite frankly, we are disappointed it’s taken this long. The last thing either need of them need during a pandemic is a hard Brexit. Right now, we still lean towards a skinny deal of some sort but it’s a very close call.

The two-day EU summit begins Thursday. The row regarding the EU’s rule of law clause continues.  Both Poland and Hungary continue threaten to veto it.  While we expect an eventual face-saving compromise that leads to unanimous approval, EU officials have been told that this Monday is the deadline to set the long-term budget.  If a deal has not been struck, the EU will operate under monthly emergency budgets as of January 1 that will force partial shutdowns and suspension of some program payments.  The EU will prioritize payments under this scenario and reports suggest Hungary and Poland will be put at the end of the line as punishment. The start of the recovery fund would also be delayed but reports suggest that the EU may carve out Hungary and Poland altogether from the fund.

The European Central Bank meets Thursday and is expected to add more stimulus. New macro forecasts will be released and are likely to support further easing. We look for an EUR500-750 bln increase in its PEPP as well as an extension to end-2021 or into 2022 vs. June 2021 currently. What else could the ECB do? It could offer another round of TLTROs at even better terms. However, we do not think the ECB will take rates more negative. We will be sending out a preview this week ahead of the meeting.

Will the ECB say or do anything about the strong euro? We’ve always felt that the ECB is more concerned about the pace of euro gains than any particular level. From July 1 to September 1, the euro gained 7% and that got the ECB’s attention. Up until last week, the pace was pretty restrained but recent price action suggest the move is starting to snowball. Since just early November, the euro is up around 4.5%. While we think this will lead to more pushback from the ECB this week, there’s really not much it can do about the exchange rate. As such, it seems like the market is pretty comfortable taking the euro higher.

It’s a light week in terms of eurozone data. Germany is the most active. It reports October IP Monday and it is expected to rise 1.6% m/m, the same as September. December ZEW survey will be reported Tuesday. The expectations component is expected to improve to 46.0 from 39.0 in November, while the current situation is expected to fall to -66.0 from -64.3 in November. October trade and current account data will be reported Wednesday, with exports expected to rise 1.3% m/m and imports by 1.2% m/m. Spain reports IP (flat m/m expected ) Wednesday, followed by France (0.4% m/m expected) Thursday and Italy (1.0% m/m expected) Friday. The eurozone IP reading will be reported December 14.

UK has its monthly data dump Thursday. October GDP, IP, construction output, services, and trade will all be reported. GDP is expected to rise 0.2% m/m vs. 1.1% in September, while IP is expected to rise 0.3% m/m vs. 0.5% in September. Construction is expected to rise 1.1% m/m vs. 2.9% in September, while services is expected to rise 0.3% m/m vs. 1.0% in September. Clearly, the economy is losing momentum and that’s even before the latest round of lockdowns. No wonder Chancellor Sunik added more fiscal stimulus and the BOE added more monetary stimulus this fall. More is likely to be required in 2021.

 

ASIA

Japan reports some limited data this week. October leading index will be reported Monday. October household spending, real cash earnings, current account, and final Q3 GDP will be reported Tuesday. Spending is expected to rise 2.4% y/y vs. -10.2% in September, earnings are expected to fall -0.4% y/y vs. -1.1% in September, and the adjusted current account surplus is expected at JPY1.829 trln vs. JPY1.346 trln in September. October core machine orders and November machine tool order will be reported Wednesday, with core orders expected to fall -11.2% y/y vs. -11.5% in September. November PPI will be reported Thursday and is expected to fall -2.2% y/y vs. -2.1% in October, suggesting deflationary pressures are building.

Next BOJ meeting is December 17-18 and reports suggest it will extend its emergency programs then. Elsewhere, Prime Minister Suga is expected to unveil a third extra budget within the next week or so and reports suggest this may not be the last one either. Much will depend on whether the economy and Suga’s popularity can recover ahead of elections late next year. In a poll conducted December 5-6, support for the cabinet fell to 50.3% from 63% the previous month, following Suga’s support down the rabbit hole. 76% of the respondents said they prefer virus control efforts to be prioritized over boosting the economy.

Australia sounded a warning about the impact on trade of its diplomatic spat with China. The value of its agricultural exports is set to decline -7% in FY2020-21 to the lowest level in five years, according to the most recent government forecasts. Agriculture has so far borne the brunt of the trade tensions, with China last month slapping anti-dumping tariffs of up to 212% on Australian wine. These came on top of existing trade restrictions on Australian timber, barley, and lobster. That said, there have been restrictions yet on iron ore, Australia’s top export to China. That sector is booming and for now should offset much of the overall pain being felt in agriculture. Indeed, the Aussie continues to gain and is on track to test the January 2018 high near .8135.