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June Starts with a Bang

Summary:
Ironically, the pandemic and progress toward a vaccine will play second fiddle to more mundane concerns in the week ahead.  Still, investors have shown that the most strained relationship between the US and China in 30 years (Tiananmen Square) is insufficient in the first instance to derail the recovery equity markets.  Major benchmarks in the US, Europe, and Asia reached new recovery highs. European heads of state will have a difficult situation later this month when they meet to find a compromise on the Recovery Plan.   The UK, in part, has left the EU because many felt it has lost its voice as more countries joined.  However, the shift to qualified majority voting from unanimity was not complete, and the decision about an EU-level response requires the assent of all members.

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June Starts with a Bang
Ironically, the pandemic and progress toward a vaccine will play second fiddle to more mundane concerns in the week ahead.  Still, investors have shown that the most strained relationship between the US and China in 30 years (Tiananmen Square) is insufficient in the first instance to derail the recovery equity markets.  Major benchmarks in the US, Europe, and Asia reached new recovery highs.

European heads of state will have a difficult situation later this month when they meet to find a compromise on the Recovery Plan.   The UK, in part, has left the EU because many felt it has lost its voice as more countries joined.  However, the shift to qualified majority voting from unanimity was not complete, and the decision about an EU-level response requires the assent of all members.  It used to be that when Germany and France agreed, it would drive Europe.  Not so quick this time.

The Berlin-Paris proposal has run into opposition by two blocs.  The first is a set of European countries that want loans not grants.  Some fear that those who clamored that the proposal was a step toward fiscal union, even though it is debatable and that many on the center-right in Germany, for example, perhaps even Merkel, does not believe it is, are right and do not want it.  Others, in Eastern and Central Europe, cringe at the Franco-German condominium and these proposals, ostensibly in their name, without consultation.

German officials, including Merkel herself, seemed to play down the likelihood that an agreement will be reached at the summit toward the middle of the month.  The funds proposed by the EU are relatively modest (750 bln euros) given the number of members (27) and the size of GDP (~17 trillion euros).  Still, for some countries, the funds could make more than a marginal difference.  Enthusiasm should be tempered by the fact what happens in an emergency or war cannot often be extrapolated to more normal times.  However, the lasting value may lay in the construction of scaffolding for the next fight over the European Project, including the strengthening of the role of the European Parliament.  The EU bonds could also provide a new benchmark for Europe, which can enhance the euro’s international role.   The ECB may not be the only central bank to buy them.  

Investors looked past this as well.  In Europe, the real and anticipated liquidity not only lifted equity markets but also narrowed the premium southern Europe pays to borrow over Germany.  The 10-year Italian premium narrowed by nearly 25 bp last week to less than 190 bp, the lowest since the crisis erupted.  It peaked near 280  bp in mid-March.  It finished last year near 160 bp.  In absolute terms, Italy's 10-year yield fell for 9 consecutive sessions until the last session, over which time it has fallen from 186 bp to nearly 140 bp.

Broadly the same is true for Spain.  The premium narrowed by 12 bp over the last week and to slip below 100 bp for the first since early March.  It was near 65 bp at the end of 2019.   It does not enjoy the same streak as Italy, but in the past two weeks, Spain's 10-year yield has fallen from 76 bp to almost 56 bp.

It is not just geopolitics or Europe's perennial challenge of joint action that investors are looking past.  Latin America, home to about 8% of the world's population, now accounts for 40% of the reported virus cases.  Brazil, Peru, Chile, and Mexico have been hit hard by the Covid-19.  Last week, the Brazilian real and Mexican peso were the strongest currencies in the world, gaining 3.8% and 3.2% respectively.  The real rose the best level since April 20, and the peso saw its best level since mid-March.

Three major central banks meet next week, the Reserve Bank of Australia, the Bank of Canada and the European Central Bank.  The first two will likely assure investors and businesses that they are prepared to do more if necessary, but are probably not going to take fresh initiatives.   On the other hand, the ECB is likely to move.  It will have the cover of new staff forecasts and ECB President Lagarde already warned that the more optimistic scenario has been superseded by events and the region's economy is between the medium and severe scenarios, which mean a contraction of around 10% this year.

The ECB is likely to increase the 750 bln euro Pandemic Emergency Purchase Program substantially.  An increase of less than 500 bln euros may be disappointing, but the reaction may also be a function of how long the program is extended. There are several other measures that the ECB may consider, but cutting interest rates deeper into negative territory is not one of them.

On the contrary, as part of a broader effort to help the financial system overcome the challenges, it could adjust the amount of deposits that are subject to negative rates.  It could broaden its corporate bond-buying program to include some bonds that recently lost their investment-grade status (fallen angels).  ECB President Lagarde is likely to stress the flexibility in its purchases and investments.  She will likely underscore the fact that EU's Recovery Bonds fit well into the ECB's bond-purchase programs.

The beginning of the monthly cycle of economic data, including the final PMI readings, may be of passing interest.  China's official and Caixin PMI will likely show a continued recovery in the world's second-largest economy.  The official PMI shows the manufacturing and service sectors have begun expanding, even if slowly, while the Caixin PMI, in which small businesses are more represented, has not confirmed it.

The US auto sales and employment data are two data highlights.  US auto sales averaged 16.9 mln last year.  It was the first year that the average was below 17 mln since 2014.  In shelter-in-place halved auto sales, which fell to 8.58 mln in April.  The recovery likely began in May with an increase to nearly 11 mln (seasonally-adjusted annual rate).   In May 2019, US auto sales were 17.3 mln.  The auto sales report will be among the first non-survey reports for May outside of the weekly jobless claims.

The US labor market remained distressed in May.  Of that, there is no doubt.  The median forecast in the Bloomberg survey calls for an 8 million decline in non-farm payrolls in May after the 20.5 mln job loss in March.  About 5% of the job loss (or 400k) is thought to come from the manufacturing sector.  The unemployment rate, derived from a different survey (households rather than establishments) may rise to almost 20% from 14.7% in April.  What the April income numbers seem to confirm (+10.5%) is that the government has replaced much of the wage income lost.

The workweek may have ticked back up to 34.3 hours, where it was at the end of 2019, after slipping to 34.1 hours in March.  Given that the 133 mln employees in the US in April, a 0.1% hour increase is the equivalent of about 380k full-time equivalents.  Average hourly earnings seem distorted by the composition of the workforce, with lower-paid workers service sector workers hit particularly hard by the shutdowns.

Canada will also report May jobs data at the end of on June 5, two days after Governor Macklem chairs his first policy meeting at the central bank.  In April, Canada lost nearly two million jobs, twice the number of jobs lost in March.  The unemployment rate rose to 13% in April from 7.8% in March, and 5.6% at the end of last year.  Canada's "hourly wage rate for permanent workers" is being distorted by the composition of the workforce.  Canada's economy was harder hit than the US in Q1.  While the US economy contracted a revised 5% at an annualized rate, the Canadian economy contracted 8.1% after barely growing in Q4 19 (0.6%).

Karin Kimbrough, chief economist at Linkedin recently shared the platform's global hiring data.  China's hiring rate has recovered over the past few months and is now near last year's levels.  Europe looks several weeks behind China.  France, Kimbrough says, is seeing hiring rates rise for the depress April lows.  The US hiring rate has leveled out about a third below year-ago levels.  Nearly a quarter of US professionals expect their earned income or wages to decline over the next six months.

Disclaimer






Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.

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