US Fiscal And UK/EU Brexit Discussions

The worse than expected US jobs report on Friday failed to stop the S&P 500 from registering another record high, but it does put even more pressure on US legislators to agree on a fiscal stimulus deal.  US November non-farm payrolls came in at 245,000, below the 460,000 consensus expectations and while the unemployment rate dropped to 6.7% from 6.9% previously this was all due a drop in the participation rate.  In other words the fact there are less people registering as actively looking for jobs has flattered the unemployment rate. Payrolls growth has slowed sharply and there are still 9.8 million more unemployed compared to February while further COVID restrictions point to more weakness in jobs ahead.  The good news is that some form of compromise is emerging on Capitol Hill, with a bipartisan proposal of $908 billion gaining traction, though frictions remain over aid to states and local governments and liability protections for businesses.

This week is crucial for Brexit transition deal discussions. The weekend phone call between UK PM Johnson and European Commission president von del Leyen made little progress on outstanding issues including fishing rights and level playing field.  Irish PM Martin noted that talks were on “a knife-edge”. European Union leaders are looking for a deal to be agreed upon before the European Council meeting on Thursday though time is running out.  The lack of progress is weighing on the pound (GBP), which took an initial dive this morning before recovering somewhat.  As it stands, the UK will leave the EU on December 31 with or without a deal.   Further complicating matters the UK’s Internal Market Bill, which gives ministers power to rewrite parts of the original Brexit divorce deal, will return to parliament today.

This week’s data and event slate is likely to kick off with upbeat Chinese November trade data; both exports and imports are likely to record healthy increases (Bloomberg consensus: exports 12.0% y/y, imports 7.3% y/y). The data is likely to bode well for risk sentiment, and for Chinese and Asian markets today.  Policy rates decisions in Canada and Europe will be of interest, especially with the European Central Bank (ECB) (Thu) likely to deliver a further easing.  Bank of Canada (Wed) is unlikely to reveal any major changes to policy.  Inflation data in China (Wed) and the US (Thu) are likely to reflect the disinflationary impact of COVID. Finally, the EU Leaders’ Summit may sign off on any Brexit agreement assuming there is one by then while an agreement on the EU Recovery Fund is unlikely to be reached.  

Split personality

Markets are exhibiting a Strange Case of Dr Jekyll and Mr Hyde, with a clear case of split personality. Intensifying risk aversion initially provoked USD and JPY strength, with most crosses against these currencies under pressure. Both USD/JPY and EUR/JPY breezed through psychological and technical barriers, with the latter hitting a nine-year low. However, this reversed abruptly in the wake of extremely poor US existing home sales, which plunged 27.2% in July, alongside downward revisions to prior months, a much bigger drop than forecast.

Obviously double-dip fears have increased but how realistic are such fears? Whilst much of the drop in home sales can be attributed to the expiry of tax credits, investors can be forgiven for thinking that renewed housing market weakness may lead the way in fuelling a more generalized US economic downdraft. The slow pace of jobs market improvement highlights that the risks to the consumer are still significant, whilst tight credit and weaker equities, suggests that wealth and income effects remain unsupportive.

FX markets will need to determine whether to buy USDs on higher risk aversion or sell USDs on signs of weaker growth and potential quantitative easing. I suspect the former, with the USD likely to remain firm against most risk currencies. The only positive thing to note in relation to the rise in risk aversion is that it is taking place in an orderly manner, with markets not panicking (yet).

European data in the form of June industrial new orders delivered a pleasant surprise, up 2.5%, but sentiment for European markets was delivered a blow from the downgrade of Ireland’s credit rating to AA- from AA which took place after the close. The data suggests that the momentum of European growth in Q3 may not be as soft as initially feared following the robust Q2 GDP outcome.

Japan has rather more to worry about on the growth front, especially given the weaker starting point as revealed in recently soft Q2 GDP data. Japan revealed a wider than expected trade surplus in July but this was caused by a bigger drop in exports than imports, adding to signs of softening domestic activity. The strength of the JPY is clearly making the job of officials harder but so far there has been no sign of imminent official FX action.

Japan’s finance minister Noda highlighted that recent FX moves have been “one sided” and that “appropriate action will be taken when necessary”. The sharp move in JPY crosses resulted in a jump in JPY volatility, a factor that will result in a greater probability of actual FX intervention but the prospects of intervention are likely to remain limited unless the move in the JPY accelerates. USD/JPY hit a low of 83.60 overnight but has recovered some lost ground, with 83.50 seen as the next key support level. JPY crosses may see some support from market wariness on possible BoJ JPY action, but the overall bias remains downwards versus JPY.

What to watch this week

The 85k drop in US non-farm payrolls in December was obviously disappointing given hopes/expectations/rumours of a positive reading over the month.  There was a small silver lining however, as November payrolls were revised to show a positive reading of +4k, the first monthly gain in jobs since December 2007.  Overall, the US labour market is still gradually improving as the trend in jobless claims and other indicators show. 

The fact that the market took the drop in US payrolls in its stride highlights the fact that recovery is becoming more entrenched despite the occasional set back.  More significantly weaker US jobs disappointment has been countered by strong Chinese trade data, which showed both strong imports and exports growth in December.  Whilst the data, especially the strength in exports, will support calls for a stronger CNY, it also highlights China’s growing influence on world trade and the important role that the country is providing for global economic recovery.

Market resilience in the wake of the drop in US payrolls and positive reaction to Chinese trade data will maintain a “risk on” tone to markets this week.  In particular, the USD is set to start the week on the back foot and despite data last week showing that Eurozone unemployment reached an 11-year high of 10% and growing evidence that the Eurozone economy is falling behind the pace of recovery seen elsewhere, EUR/USD held above technical support (200 day moving average) around 1.4257, and is setting its sights on the 16 December 2009 high of 1.4591 helped by renewed Asian sovereign interest.  

The main event in the Eurozone is the ECB meeting on Thursday no surprises are expected, with the Bank set to keep policy unchanged whilst maintaining current liquidity settings.  The bigger concern for European markets is ongoing fiscal woes in the region, with press reports warning of a ratings downgrade for Portugal and still plenty of attention on Greece and its attempts at deficit reduction.  Fiscal concerns are not going to go away quickly and will clearly act as a restraint on market sentiment for European assets. 

In a holiday shortened week in the US as markets close early on Friday ahead of the 3-day MLK holiday, there are a number of data this week that will shed further light on the shape of US recovery. The main event is the December advance retail sales report on Thursday, which is expected to record a reasonable gain, helped by firm autos sales. 

Preceding this, tomorrow there is expected to be a renewed widening in the US trade deficit in November whilst on Wednesday the Fed’s Beige Book as well as various Fed speakers this week including Bullard, Lockhart, Fisher, Plosser, Evans and Lacker, will give important clues ahead of the January 27 Fed FOMC meeting.  Bullard sounded dovish in his comments in Shanghai, as he highlighted that US interest rates will remain low for some time. 

At the end of the week there will be a heavy slate of releases including December CPI, industrial production, capacity utilization, January Empire manufacturing and Michigan confidence. The outlook for these data is generally positive, with gains expected in both manufacturing and consumer confidence, whilst hard data in the form of industrial production is likely to record a healthy increase and CPI is set to reveal another benign reading.

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