THREE FUNDAMENTALS FOR THE WEEK AHEAD
Lots of focus on the US this week. Here are the key themes we are looking out for…
1) FOMC Rate Decision
No big policy change are expected at this week’s FOMC meeting, therefore volatility will likely not be too much (although most expect the Fed’s continued dovish tone to support risk assets such as US equities.
Despite the rise in Covid-19 cases in the US, which looks likely to have slowed economic activity in the US in the month of July (ING forecast that NFP could show the US economy losing jobs net/net in July), financial markets continue to “function well” – i.e. equities are at or close to all-time highs, bond yields are very low (meaning the US government can borrow cheaply) and money markets are functioning well (meaning the Fed no longer has to do enormous repo operations).
Therefore, as far as the Fed is concerned, there is no immediate rush to come forward with more stimulus just yet – but that does not mean more stimulus isn’t already on the way. This stimulus is more aimed at assisting with the economic recovery, rather than the crisis containment stimulus we saw back in March (when markets were selling off and the Fed was axing rates 100bps at a time and pumping markets with ungodly amounts of QE).
Forward guidance is the discussion – the Fed might in the coming meetings lay out more specific conditions it would like to see before raising rates; i.e. sustained move in core measures of inflation above the 2% target and a return to the unemployment rate to below 3.5% (for example!). Another type of forward guidance they could try is yield curve control – where they set a target for US government bond yields to ensure that the government can continue to borrow at favourable rates.
2) US Q2 GDP – The worst quarter ever
Markets forecast a stunning 35% drop in GDP in Q2, at a Q/Q rate. This drop reflects the impact of Covid-19 lockdowns, which closed huge sectors of the economy and has since put many Americans out of work. Much of this decline will be quickly recouped, with people returning to work in Q3 across much of the country from May onwards (though the recent resurgence of the virus will not be helping this reopening).
Looking to the quarters ahead, and those beyond when a Covid-19 vaccine is discovered and rolled out and we can all return to normal life, markets will be most interested to know the scarring that the pandemic left on the economy (i.e. how much permanent damage was done that reopening the lockdowns can’t solve).
Despite the fact that this data is backward looking, (after all, we are now nearly one month into Q3 already), a big miss on expectations (imagine is GDP actually contracted at a Q/Q rate of 40% in Q2 instead) will likely be a risk appetite and USD negative. A big beat on expectations could be a risk appetite and USD positive.
3) US Fiscal Stimulus Package Four
With current emergency unemployment insurance (implemented by the US Congress in an emergency fashion back in March to support the incomes of those millions of Americans who had been thrown off of work due to Covid-19 lockdowns) set to expire at the end of the week, the race is on in the US Congress to agree on a replacement. If not, US GDP will suddenly plunge to reflect the sudden drop in income of unemployed persons.
After much delay (which weighed on risk appetite last week), the Republican Party is set to unveil a bill this evening, though there are some suggestions that it may amount to just $200 per week for unemployed people, as opposed to the $600 they are currently getting.
Should Congress succeed in passing the bill by the end of the week, this should be a risk appetite positive. Should they fail, this will be bad for risk appetite, with the US economy facing a sudden shock at the start of next week.
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