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All Together Now

by Karl Schamotta | May 3, 2021

MAY 2021  KARL SCHAMOTTA, CHIEF MARKET STRATEGIST

It may have taken a worldwide pandemic, a tectonic political shift, and unprecedented amounts of fiscal stimulus – but the “synchronized global growth” outlook that many economic pundits expected in early 2020 seems to be materializing. 

What’s happening: Rapidly accelerating vaccination programs are clearing the way for a lifting of social distancing restrictions in many industrialized nations over the next two months. A vast amount of stimulus money is leaking – via American consumer purchases – into the global economy, lifting exports from emerging markets, commodity producers, and manufacturing powers alike. And in the US itself, fiscal stimulus expectations are softening while vaccine hesitancy slows progress toward herd immunity.

The US isn’t slowing down, others are catching up.

Monetary policy gaps are narrowing: With economic slack disappearing in several advanced economies, central banks are beginning to shift communication strategies, preparing to gradually wind down emergency monetary stimulus. The Bank of Canada was the first to leap off the starting block, reducing the pace of asset purchases and signalling a 2022 rate hike when it met last week, but pressure to outline an exit plan is growing on the Bank of England, European Central Bank and Reserve Bank of Australia, among others.

Why it matters: Interest rate differentials that had been grinding inexorably in the dollar’s favour have reversed direction, lending support to currencies which spent much of the first quarter on the defensive. With clear-cut trading narratives eroding, implied volatility levels have fallen sharply across the G10 currency landscape.

And yet: The old “sell in May and go away” cliché could play out in reality over the coming month. With values at nose-bleed levels, good news priced into most asset classes, and regional idiosyncrasies smoothed over through the massive application of liquidity, market positioning looks dangerously homogenous and complacent.

 

UNITED STATES  548 WORDS, 1.8 MINUTE READ

American Exceptionalism?


The trade-weighted dollar fell consistently through April, ending almost 3% weaker as the American outperformance trade collapsed.

What’s happening: US exceptionalism – in fiscal spending and vaccine distribution – pushed yields higher and pulled capital into the dollar through the early part of the year. But with government stimulus priced in and vaccinations accelerating in other major economies, expectations for outperformance are now fading.

Vaccination rates are rising more slowly: Hesitancy has begun to exert drag on daily inoculation rates, threatening to narrow the gap with other countries.

Vaccine Hesitancy?
DAILY NUMBER OF COVID-19 VACCINATION DOSES ADMINISTERED PER 100 PEOPLE, 7-DAY ROLLING AVERAGE
2020 DEC 21 – 1 MAY 2021


SOURCE: OUR WORLD IN DATA, AUTHOR CALCULATIONS, 2021

Growth continues to rebound: In real terms, the American economy expanded 6.4% in the first quarter, leaving it just 0.9% below the peak reached 15 months ago.

Job markets are healing: Unemployment claims continue to tick downward, and another blockbuster number is expected when the April non-farm payrolls report is released on Friday. Markets are currently positioned for a 925,000-position jump, with the headline unemployment rate dropping to 5.8% from 6.0%. If these estimates prove correct, more than 14 million jobs will have been added over the last year, leaving overall employment almost 8 million below pre-pandemic levels.

The Fed is keeping liquidity flowing: Surprising no one, the world’s most powerful central bank kept policy settings unchanged in April, committing to keeping rates low until the labor market attains maximum employment, and inflation reaches 2% and is on track to moderately exceed 2% for some time. Chairman Jerome Powell told a post-meeting press conference that the recovery has been faster than expected but “it remains uneven and far from complete” and “the economy is a long way from our goals and is likely to take some time for substantial further progress to be achieved.”

Markets are not taking Powell at face value: Yields began creeping up after the meeting, and Eurodollar futures were priced under the assumption that the central bank will hike initially in 2023, with two more increases expected by March the following year – well before the Fed’s own forecast for a 2024 liftoff.

But this may be part of the bank’s master plan: In allowing markets to push rates higher on their own, the Fed may be pre-emptively narrowing the gap that will inevitably snap closed when tapering is eventually discussed.

Bottom Line: With no rate-setting meeting, economic outlook or dot plot scheduled for release in May, markets will have to take policy guidance from the open-mouth operations conducted by Federal Open Market Committee members in interviews and speeches. Less weight should be placed on comments from non-voting (alternate) officials.
Absent a major negative economic shock, speculators look likely to add to their bets against the dollar in the month ahead. Further declines – particularly relative to the euro and commodity bloc currencies – look likely.

Potential Volatility Catalysts:
5       ADP Employment Report, April
5        Federal Open Market Committee Alternate Member Evans Speaks
5        Federal Open Market Committee Voting Member Mester Speaks
6        Weekly Jobless Claims
7        Non-Farm Payrolls, April
11        Job Openings and Labor Turnover Survey, March
12       Consumer Price Indices, April
12        Federal Open Market Committee Voting Member Clarida Speaks
13       Federal Open Market Committee Alternate Member Bullard Speaks
13        Weekly Jobless Claims, May
14        Retail Sales, April
19        Federal Open Market Committee Meeting Minutes, April
20        Weekly Jobless Claims
27        Durable Goods Orders, April
27        Weekly Jobless Claims

 

CANADA  640 WORDS, 2.1 MINUTE READ

Loonie Bin


The Canadian dollar remains at the top of the G10 league table, rising 3.6% against the dollar year to date, up 2.4% in the last month alone. 

Global growth expectations are going parabolic: Concerted fiscal stimulus, loose monetary conditions, and easing restrictions are pushing investors to discount a multi-year surge in growth – and this is providing the locomotive force to pull virtually every major asset class higher.

Commodity prices are soaring: Oil prices are up, but raw materials like lumber and copper are up even more. This is likely to have a modest impact on the broader Canadian economy (resource-producing sectors have shrunk as a share of the total over the last two decades), but should provide a partial offset against a consistently-negative current account.

Vaccine distribution is accelerating: A series of missteps have broken domestic confidence in Canada’s immunization campaign, but the country’s performance looks respectable in comparison with other major economies. On the current trajectory, the bulk of the adult population is likely to have received at least one shot by the end of June.

Consumers are spending like there’s no tomorrow: With monetary stimulus loosening financial conditions and fiscal stimulus spending pouring into the economy, real estate prices continue to rally higher. Homeowners, having long ago grown comfortable with prices outpacing disposable income, are seeing higher equity values increase borrowing – and spending – capacity.

Soaring Wealth Effects
REAL DISPOSABLE INCOME V. REAL HOME PRICE INDICES, REBASED, 1975 = 100
​​​​​1975 Q1 – Q4 2020 

SOURCES: MACK, A., AND E. MARTÍNEZ-GARCÍA. 2011. “A CROSS-COUNTRY QUARTERLY DATABASE OF REAL HOUSE PRICES: A METHODOLOGICAL NOTE.” GLOBALIZATION AND MONETARY POLICY INSTITUTE WORKING PAPER NO. 99, FEDERAL RESERVE BANK OF DALLAS, AUTHOR CALCULATIONS, 2021

The economy is close to full recovery: Preliminary estimates suggest that output rebounded to within 98.7% of pre-COVID levels by the end of March.

Interest differentials are tilting: With growth tracking very close to its 6.8% full-year forecast and price pressures building, the Bank of Canada has already begun tapering and has led markets to expect a rate hike in 2022 – putting it on course to become the first major central bank to reach escape velocity. With the Fed remaining stubbornly dovish, Canada has become an extreme outlier – three rate hikes priced into the next two years have tilted rate spreads in the loonie’s favour.

The exchange rate looks likely to overshoot: Investors continue to rebalance away from the ‘US outperformance’ theme that dominated flows through the first quarter, and the psychological 1.20 barrier looms as a near-term target for momentum traders.

But similarities to 2009 are stacking up: Then, as now, a global economic recovery was discounted more quickly and aggressively in commodity markets than elsewhere. Then, as now, a surge in liquidity-driven speculative activity (driven by fears of a surge in inflation which never materialized) added to this move, sending raw materials indexes soaring. Then, as now, strength in the Canadian housing market boosted consumer spending. Then, as now, the Bank of Canada was expected to engage in a rapid-fire series of rate hikes before the Federal Reserve reached liftoff.

Long-term risks to the Canadian dollar’s strength are stacking even higher: If global growth disappoints or production bottlenecks ease in the coming months, commodity demand expectations could weaken. If inflation proves transitory, the speculative narrative driving prices could collapse. Global housing markets are showing signs of deceleration. And although the Bank of Canada might make its first move in relatively close synchrony with the Fed, elevated household debt levels seem likely to flatten the trajectory from there.

Bottom line: The loonie looks poised for a run at the 1.20 mark against the dollar – but could find its wings melting once that target has been hit.

Potential Volatility Catalysts:
4      Building Permits, March
5      US Energy Information Administration Petroleum Status Report
7      Labour Force Survey, April
11    US Energy Information Administration Short-Term Outlook, May
12    US Energy Information Administration Petroleum Status Report
13    Bank of Canada Governor Tiff Macklem Speaks
14    Existing Home Sales, April
17    Housing Starts, April
19    Consumer Prices, April
19    Teranet/National Bank Home Price Index, April
19    US Energy Information Administration Petroleum Status Report
21    Retail Sales, March
26    US Energy Information Administration Petroleum Status Report
27    Payroll Employment, Earnings and Hours, March

 

MEXICO  350 WORDS, 1.1 MINUTE READ

Mexican Standoff


The peso has fallen less than -1.75% this year, outperforming many of its emerging market peers even as US yields climb.  

Mexico’s fiscal discipline continues to support credit ratings: Government deficits are set to widen only slightly in 2021, to roughly 4.1% of GDP. This has improved the country’s sovereign risk profile relative to its peers in Latin America, and is helping the currency win the “reverse beauty contest” that has gripped the emerging markets.

Reverse Beauty Contest
​​CHANGE IN USD EXCHANGE RATE, YEAR TO DATE
2021 JAN 03 – 01 MAY 2021

SOURCES: BLOOMBERG, AUTHOR CALCULATIONS, 2021

This frugality cuts both ways: Household consumption has failed to keep pace with growth in other areas of the economy throughout the pandemic recovery period.

But domestic demand is reviving: The country’s trade balance swung into negative territory in March, with a massive 36.5% year-over-year rise in imports outstripping a 12.2% increase in exports.

Growth is beating expectations: Seasonally-adjusted GDP rose 0.4% quarter-on-quarter in the first three months of 2021, defying forecasts from private sector economists and the central bank alike.

Exports are poised for a rebound: A protracted chip shortage could continue to weigh on the auto sector over the next month or so, but soaring US consumption and elevated commodity prices should provide sustained lift through the northern summer.

The Banco de México is on hold: The economy’s strength argues against providing any additional monetary accommodation at this time, and transitory inflation effects are unlikely to prompt a policy response.

President Andrés Manuel López Obrador remains popular: A recent poll suggested that 59% of uninoculated citizens approved of his leadership, with support even higher among those who had received a jab. Mid-term elections in June should provide an opportunity to broaden control in Congress and across the states. Investment-unfriendly reforms and tight fiscal policy settings are probably here to stay.

What’s next: Stronger than expected inflation data due at the end of the week could set the stage for a slight hawkish turn in communications from the Banxico on May 13. But changes in the global yield landscape – ultimately driven by shifting monetary and fiscal policy expectations in the United States – are more likely to provide the trigger for explosive moves.

Bottom line: Higher vaccination rates, a brightening external demand outlook, and renewed dollar weakness might provide the narrative needed to propel the peso upward in the month ahead, but the currency could encounter resistance around the 19.75 mark and tread water for some time.

Potential Volatility Catalysts:
7       Consumer Price Indices, April
13     Banco de México Rate Decision
21     Retail Sales, March
25     Trade Balance, April
27     Unemployment, April
27     Banco de México Monetary Policy Minutes

 

EURO AREA  457 WORDS, 1.5 MINUTE READ

Great Expectations


The euro reversed direction in April, climbing 2.2% against the dollar – but sharp losses in the first quarter have left it -1.6% weaker on a year-to-date basis. 
​​​​​
What’s happening: A poorly-coordinated vaccine distribution campaign left most major European economies languishing under social distancing measures through the first quarter. The bloc fell back into recession, with output shrinking 0.6%, contrasting unfavourably with a 1.6% expansion in the US over the same period.

But the hit was smaller than feared: Businesses and consumers appear to have adapted, becoming more resilient under lockdown conditions as the pandemic stretched on.

Vaccine rollouts are accelerating: Many of the supply restrictions that initially held the region back have largely been resolved, and member country health authorities are becoming more efficient in distribution – 4.3% of the adult population was inoculated last week, and the rate of growth is trending upward.

Catching Up
SHARE OF POPULATION WHO HAVE RECEIVED AT LEAST ONE DOSE OF COVID-19 VACCINE 
2020 DEC 21 – 01 MAY 2021


SOURCE: OUR WORLD IN DATA, AUTHOR CALCULATIONS, 2021

Governments are likely to begin lifting restrictions in early May: By some estimates, European consumers have squirreled away more than 170 billion since the pandemic began, suggesting that pent-up demand could fuel a powerful rebound during the summer months. The European Central Bank expects the eurozone economy to grow 4% over the course of the year, with output returning to pre-pandemic levels in 2022.

Consensus currency market forecasts have been adjusted sharply upward: A number of major institutions expect the currency to trade with a 1.26 to 1.28 handle by year end.

But European tapering is likely to happen well after the Fed reaches liftoff: Although the gap between US and European growth rates is expected to narrow in the second half, it won’t disappear – suggesting that interest rates are likely to lag American yields through the post-pandemic recovery period.

French politics also bear monitoring: The notoriously eurosceptical Marine Le Pen has moved up in opinion polls, narrowing the gap against sitting president Emmanuel Macron. Implied volatility levels around the April 2022 election have moved up, suggesting that markets are becoming nervous. A slower than expected recovery over the next month could weaken Macron further, increasing the risk discount applied to the euro as a whole.

Bottom line: Momentum could carry the common currency higher into May, but market participants should be wary of moving too far, too fast. The European economy’s long record of recovering more slowly than the United States remains painfully intact.

Potential Volatility Catalysts:
5          European Central Bank Chief Economist Lane Speaks
6           European Central Bank Economic Bulletin
6         Retail Sales, March
7          European Central Bank President Lagarde Speaks
18       Employment, Euro Area, Q1
18       Gross Domestic Product, Q1
19         Consumer Prices, April

 

UNITED KINGDOM  483 WORDS, 1.6 MINUTE READ

Scot Free?


The pound has advanced 1.1% against the dollar, and 2.74% against the euro this year, but momentum is clearly fading.

The United Kingdom’s vaccination effort has met with resounding success: Some 48 million shots have been administered so far, with more than half the population receiving at least one jab.

Pent-up consumer demand is being unleashed: Hiring rose sharply before social distancing restrictions were eased in early April, and high-frequency data suggests that spending skyrocketed as pubs and retailers welcomed customers once again.

Business investment is recovering, albeit more slowly: With reopening expected to last, tax incentives kicking in, and Brexit-related uncertainties in the rear-view mirror, sentiment indicators suggest that capital outlays will stay on an upward trajectory through the next quarter, if not beyond.

The Bank of England is moving toward tapering: Incoming data has consistently outperformed expectations over the past three months, and officials are likely to unveil upgraded growth projections on Thursday. A forecast fall in output during the first quarter should be revised lower, while a second quarter rebound is adjusted higher.

But the Bank is unlikely to cut asset purchases at the May meeting: Relative to pre-pandemic levels considerable economic slack remains, with employment levels and inflation rates still far below target.

The Scots are getting restless: The pro-independence Scottish National party is on course to build a dominant coalition – or achieve an outright majority – in Thursday’s election. Under Nicola Sturgeon, the party is expected to call for a fifth referendum on the country’s constitutional status.

This might trigger foreign exchange volatility: Approximately 7.5% of the UK’s economic output is generated in Scotland and a conclusive separatist victory could raise the odds on a full dismantlement of the United Kingdom. During the last referendum in 2014, the pound dropped sharply when several strongly pro-independence polls were released just before the voting date.

Keep the Heid
GBPUSD SPOT EXCHANGE RATE DURING 2014 SCOTTISH INDEPENDENCE REFERENDUM
2014 AUG 28 – 30 SEP 2014

SOURCE: BLOOMBERG, AUTHOR CALCULATIONS, 2021

And yet: An independence vote isn’t expected until the end of 2023 at the earliest, with political and procedural hurdles making an exit extremely unlikely before 2025. It is doubtful whether foreign exchange markets – which largely failed to incorporate Brexit-related risks until the referendum itself – will react in a sustained way.

Bottom line: The Bank of England decision on Thursday could trigger position washouts, particularly if accompanied by more dovish-than-expected rhetoric from officials – but we suspect that the Scottish election is more apt to generate short-term instability in the pound. With investors crowded into long-sterling positions and a number of downside catalysts looming, it might take a brave heart to bet on a sustained break through the 1.40 threshold.

Potential Volatility Catalysts:

6        Bank of England Rate Decision
6        Scotland Elections
6        UK Local Elections
7        Bank of England Deputy Governor Broadbent, Chief Economist Haldane Speak
12      Gross Domestic Product, Q1
12      Bank of England Governor Bailey Speaks
18      Jobless Claims, April
19      Consumer Prices, April
21      Retail Sales, April.

 

CHINA  368 WORDS, 1.2 MINUTE READ

Main Squeeze


The Chinese renminbi is up 0.8% against the dollar year to date, reversing losses sustained at the tail end of the first quarter.

What’s happening: Chinese output continues to surge higher, with domestic demand beginning to pick up the slack as the country’s exporters face growing headwinds.

Consumer confidence has improved: Household spending is rising as restrictions are lifted, the job market recovers, and pent-up demand is released into the economy.

Inflation looks set to decline: With African swine fever largely in remission, pork costs are stabilizing, alleviating pressure on headline price measures.
The economy remains far too reliant on credit creation: debt as a share of gross domestic product continues to rise, putting the financial system at risk in the long term.

From the surface, the problem looks likely to grow: The People’s Bank of China has kept benchmark lending rates unchanged for 12 consecutive months, and official statements of concern over debt levels have been largely relegated to the opinion pages in state-owned newspapers.

Other signs suggest China is cracking down on credit growth however: Total Social Financing, a measure of lending within the financial system has begun to fall, and the country’s credit impulse is rolling over. Authorities have reportedly asked banks and other major institutions to reduce lending activities, while imposing new macroprudential rules on overleveraged property development sector.
​​​​​
Credit Crunch
BLOOMBERG CREDIT IMPULSE INDEX, YEAR-OVER-YEAR CHANGE
2020 DEC 21 – 01 MAY 2021

SOURCE: BLOOMBERG, AUTHOR CALCULATIONS, 2021

The implications for the renminbi are limited: Extraordinarily-wide yield differentials are likely remain intact until China’s enormous appetite for foreign capital has been sated – inward investment flows should continue pushing the exchange rate gradually higher.

But global commodity prices could prove vulnerable: If authorities are successful in restraining credit growth, onshore fixed investment and speculation activities might slow, causing ripple effects far beyond China’s shores.

Bottom line: China’s control over the renminbi exchange rate – backed up by what appears to be a concerted intervention apparatus – continues to ensure that upside potential against the dollar is limited. But currency market participants should be monitoring developments within the country’s gargantuan financial system.

Potential Volatility Catalysts:
6      Caixin Purchasing Manager Indices, April
6      Trade Balance, April
8      Aggregate Financing, April
10    Consumer Prices, April
16    Retail Sales, April
16    Industrial Production, April
30    Composite Purchasing Manager Indices, May

 

JAPAN  400 WORDS, 1.3 MINUTE READ

What’s Up Suga?


The Japanese yen has posted the worst performance in the G10 this year, down 5.5% against the dollar thus far. 

What’s happening: A fourth wave of coronavirus infections has hit, forcing the government to put the Tokyo, Osaka, Kyoto and Hyogo prefectures under lockdown – only three months before the Summer Olympics are slated to start.

Japan is losing the vaccination race: The country’s health ministry has only authorized one vaccine – made by Pfizer/BioNTech – and distribution is progressing at a glacial pace. Just a little over 1% of the population had received a first dose as of April 27, and only 951,490 citizens were fully immunized.

Near-term export weakness is in the cards: Shutdowns and semiconductor shortages are likely to slow shipments of high-value electronics and autos in the coming month, but solid external demand – particularly from China and the United States – should mean that longer-term damage is limited.

The Bank of Japan’s inflation goals remain unreachable: Headline prices have fallen for six consecutive months, and central bankers don’t expect a push beyond the 1% threshold until 2023 at the earliest.

Carry is back: After its brief flirtation with risk-on status late last year, crashing yield differentials have pushed the yen back into its traditional role in funding global interest rate arbitrage trades – a function that tends to put consistent downward pressure on the exchange rate.

Carry On
YIELD DIFFERENTIAL BETWEEN UNITED STATES AND JAPAN GOVERNMENT BONDS, BASIS POINTS
2020 JAN 3 – 1 MAY 2021

SOURCE: BLOOMBERG, AUTHOR CALCULATIONS, 2021

But more stimulus could come before the Olympics: Prime Minister Yoshihide Suga and his Liberal Democratic Party have seen support slide in recent months, and polls suggest that more than 77% of voters would like to see the global athletic event cancelled outright. With a party leadership contest beckoning in September and a general election due before the end of October, Suga may be motivated to announce additional spending initiatives in the coming weeks or months.

Bottom line: Ramped-up fiscal stimulus and export growth should lift the fortunes of Japan Inc. through the latter half of the year, but an ultra-loose monetary policy outlook should keep the yen restrained in the here and now. We expect the currency to lag other majors in the event that the dollar continues to suffer broad-based weakness.

Potential Volatility Catalysts:
5      Bank of Japan Meeting Minutes, March
17    Gross Domestic Product, Q1
19    Trade Balance, April
20    Consumer Prices, April
30    Industrial Production, April
30    Retail Sales, April

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