Markets Search for Direction as Q3 Begins

  • Markets are searching for direction as Q3 gets under way; the dollar has hung on to most of its recent gains
  • Ahead of tomorrow’s jobs data, we will get some final clues today; FOMC minutes will be released; Powell and Mnuchin offered differing views on the economy
  • Firm eurozone final June manufacturing PMIs were reported; EMEA manufacturing PMIs were also upbeat
  • The Riksbank surprised with an expansion of QE whilst keeping rates on hold, as expected
  • Bank of Japan released its Q2 Tankan survey; Caixin reported its China manufacturing PMI for June; Korea reported weak June trade data

Markets are searching for direction as Q3 gets under way. Q2 was a strong quarter for major and EM equity indices, but we suspect Q3 will be much more difficult in light of the conflicting drivers that have developed. The S&P 500 led the pack, up 20% for its best quarter since Q4 1998. The US was followed by Japan (+17.8%) and the EM MSCI index (+17.0%). Europe (+12.6%) and especially the UK (+8.8%) lagged. It’s a similar picture for the year, with the S&P 500 down 4% but the Nasdaq up 12%, in contrast to losses ranging from 6% (Dax) to 24% (Spanish Ibex).

The dollar has hung on to most of its recent gains. DXY traded yesterday at the highest level since June 2 and is on track to test that day’s high near 97.739. It has retraced nearly half of its late May-June drop and a break of the 98.348 area is needed to set up a test of the May 25 high near 99.975. The euro remains heavy and is once again testing support near $1.12. Sterling is struggling to break above $1.24, while USD/JPY may record an outside down day after failing to make a clean break above 108 earlier today.

AMERICAS

Ahead of tomorrow’s jobs data, we will get some final clues today. ADP will release its reading of private sector jobs and consensus is at 2.9 mln currently. ISM manufacturing PMI will also be reported and is expected at 49.7 vs. 43.1 in May. The employment component will be closely. Final Markit manufacturing PMI will also be reported. Note that yesterday’s downside miss for Chicago PMI (36.6 vs. 45.0 expected) suggests risks are tilted to the downside for the ISM reading today, though the two series do not always line up well. Of note, the employment component for Chicago PMI fell 5.1 points. June Challenger job cuts and May construction spending (1.0% m/m expected) will also be reported.

FOMC minutes will be released. Not much insight is expected, as Powell went ultra-dovish at the press conference. Not surprisingly, recent virus numbers have reinforced Powell’s ultra-dovish message. That is, “we’re not even thinking about thinking about hiking rates.” The Fed is likely to acknowledge some improvement in the data but also likely to stress the downside risks emanating from the worsening virus numbers. Next FOMC meeting is July 28-29. Evans hosts a community forum today.

Testifying before a House panel yesterday, Fed Chair Powell and Treasury Secretary Mnuchin offered differing views on the economy. Mnuchin spoke of a strong rebound in the second half of the year but added that another relief package is being discussed. Powell was more cautious, noting some improved data but again stressed the need to keep the virus in check. In other words, without successfully limiting the spread of the virus, there will be no recovery to speak of. We concur with Powell. For our latest thoughts on the US outlook, please see Virus Numbers Pose Headwinds to US Economy.

Colombia central bank cut its target rate by less than expected but announced more liquidity measures. Officials opted for a more modest 25 bp cut, bringing the overnight lending rate to 2.50%, in contrast to the previous three moves of 50 bp. Two of the five MPC members dissented in favor of a 50 bp move. The tone of the statement was more cautious, suggesting that we are entering the fine-tuning stage of the easing cycle. However, this doesn’t mean easing is done. On the liquidity front, the bank announced unlimited repo lending against securitized repo loans as collateral, along with 9- and 12-month repo loans with government bonds as collateral. Lastly, it will roll over all NDF’s with maturity in July. The peso was little changed yesterday but remains 13% weaker against the dollar year to date.

EUROPE/MIDDLE EAST/AFRICA

Eurozone final June manufacturing PMIs were reported. The region’s headline reading rose to 47.4 from 46.9 preliminary. Italy and Spain improved significantly from May to 47.5 and 49.0, respectively, while France and Germany improved from the preliminary readings to 52.3 and 45.2, respectively. Final services and composite PMIs will be reported Friday. Elsewhere, Germany reported strong May retail sales and June unemployment data. Sales jumped 13.9% m/m vs. 3.5% expected and a revised -6.5% (was -5.3%) in April. The y/y rate rose to 3.8% from a revised -6.4% (was -6.5%), while unemployment rose only 69k vs. 120k expected and a revised 237k (was 238k) in May. The eurozone data this week underscore our belief that it will likely outperform the US in H2. Most nations have successfully flattened the virus curve, whilst the US virus numbers are still hitting new highs.

EMEA manufacturing PMIs for June were also upbeat. We had upside surprises in Hungary (47.0), Poland (47.2), and Russia (49.4). Czech Republic’s reading was at expectations (44.9), while Turkey’s improved sharply to 53.9 from 40.9.

The Riksbank surprised with an expansion of QE whilst keeping rates on hold, as expected. The bank expanded its purchase program to SEK500 bln from SEK300 bln, extending it to mid-2021, and will add corporate debt to its program in September. This should serve as a headwind for the krona, which is already underperforming today, but equity markets are up 0.8%, outperforming the region. Its flat rate path was extended to at least the beginning of 2023 after being kept flat for only one year out at its April meeting due to the uncertain situation.

ASIA

Bank of Japan released its Q2 Tankan survey. Large manufacturing index came in at -34 vs. -31 expected and -8 in Q1, while the outlook came in at -27 vs. -24 expected. Large non-manufacturing index came in at -17 vs. -20 expected and +8 in Q1, while the outlook come in at -14 vs. -15 expected. Large all industry capex is expected to rise 3.2% vs. 1.3% consensus and 1.8% in Q1. Final June manufacturing PMI was also reported and improved to 40.1 from 37.8 preliminary. The economy started to turn the corner in June and so the Q3 Tankan should reflect some improvement. However, full recovery is still a ways off and so for now, the Bank of Japan is in wait and see mode.

Caixin reported its China manufacturing PMI for June. It came in at 51.2 vs. 50.5 expected and 50.7 in May. This comes after official readings came in better than expected yesterday. Caixin services and composite readings will be reported Friday, with services expected at 53.0 vs. 55.0 in May. If so, this could drag the composite lower from 54.5 in May. Elsewhere, the US offensive against China continues, and back to the IT front. The Federal Communications Commission designated Huawei and ZTE as national security threats, thereby further expunging its presence from the country.


Korea reported weak June trade data. Exports contracted -10.9% y/y vs. -9.1% expected and -23.6% in May, while imports contracted -11.4% y/y vs. -10.1% expected and -21.0% in May. Korean trade data is considered to be the regional bellwether, and the June data do not seem to reflect much improvement yet. Korea’s manufacturing PMI rose to 43.4 in June from 41.3 in May, which simply implies contraction at a somewhat slower pace.