Second Wave Could Be On The Way
SECOND-WAVE REALITY CHECK
Financial market participants reflected on the strong rally in risk assets in recent weeks amid concerns of a second wave of Covid-19 infections, especially with reports of renewed rises in cases in the US. Added to that was a very cautious message from the US Federal Reserve which, despite leaving policy settings unchanged this week, warned of ‘considerable risks’ to the economic outlook and reiterated that it is prepared to provide more stimulus in the future. The recovery in risk sentiment, which had led the US S&P equity index to erase its 2020 losses, faltered this week although there was a partial recovery on Friday. The FTSE All-Share index fell about 5% on the week. The breakout in the US 10-year Treasury yield towards 1% seems to have been premature as it fell back to 0.70%, while the 10-year gilt yield declined to around 0.20%. Brent crude oil fell back below $40pbl, although it is still more than double its April low. In the currency markets, there was renewed safe-haven demand for the US dollar, helping to push GBPUSD down from the recent high of just above 1.28 towards 1.25. Near-term market sentiment may well be driven, at least in part, by Covid-19 data, but investors will also be watching closely a raft of UK, US and Chinese data releases next week, as well as central bank policy decisions particularly from the Bank of England and the Bank of Japan. Sterling markets will also be watching Brexit headlines, with high-level talks planned on Monday between PM Boris Johnson and European Commission President Ursula von der Leyen with the aim to inject momentum into the stalled negotiations on a future relationship. The EU leaders’ summit (Thu/Fri), meanwhile, is expected to focus on the proposed coronavirus recovery fund.
BANK OF ENGLAND TO PROVIDE FURTHER SUPPORT
Backward-looking official data confirmed our expectations that the UK economy shrank by about 20% in April which was on top of the 5.8% decline in March when lockdown measures began to be implemented. The ONS said that construction activity fell by 40.1%, while industrial output dropped by 20.3%, including a 24.3% decline in manufacturing, and services by 19.0%. With lockdown measures starting to be eased in May, April is likely to have been the low point for the economy. We predict a significant rebound in next week’s UK May retail sales (Fri) of 11.0% (including fuel) following the 18.1% fall in April. However, the labour market figures (Tue) are expected to show a sharp fall in employment and higher unemployment for the single month of April. The headline figures will mask the deterioration to some extent as they cover a rolling three-month period, which we predict will show a 10k fall in employment and a rise in the unemployment rate to 4.3% from 3.9%. UK CPI inflation (Wed) is also forecast to fall to 0.5% in May from 0.8%, driven mainly by lower energy prices reflecting the lagged impact of lower global oil prices. BoE Governor Bailey’s letter to the Chancellor to explain why inflation is below target and what the Bank is doing to correct this will be published on Thursday. Recent comments from BoE MPC members have indicated they are ready to increase the £645bn limit on asset purchases given that it is likely to be reached in July. The last policy meeting in May saw two MPC members (Michael Saunders and Jonathan Haskel) vote for an immediate £100bn rise in the QE envelope. We expect all nine members will agree to that at this month’s meeting (Thu), raising the target to £745bn. The debate on the merits of reducing interest rates into negative territory continues, both in the UK and US. The BoE, however, is expected to leave Bank Rate at 0.1% next week and there is also no press conference.
FED CHAIR POWELL REMAINS CAUTIOUS ON OUTLOOK
Fed Chair Powell makes his semi-annual testimonies to Congress next week starting with the Senate (Tue). He is expected to reiterate comments made this week following the FOMC meeting which left interest rates at the zero lower bound and maintained asset purchases under QE “at least at the current pace”. Policymakers remain cautious about the economic outlook beyond the expected short-term rebound in activity, and reiterated their readiness to add more stimulus should it be needed. Markets will be listening carefully to get more of a sense of what it would take for policy to be loosened further and how seriously measures such as negative interest rates and yield curve control are being considered. There is a significant slate of US data releases, including May figures for retail sales (Tue), industrial production (Tue) and housing starts and permits (Wed). June surveys will also be released, including the Empire manufacturing (Mon), NAHB housing (Tue) and Philly Fed business (Thu) reports. Weekly jobless claims (Thu) will also be closely watched. Overall, we expect the data to show rebounds in May and for sentiment to improve in June. Our forecasts are for headline retail sales and industrial production to rise 6.5% and 2.5% respectively, partially offsetting the declines in April. Strong rises in housing starts and permits of 20% and 14% are also predicted. We see improvements in the aforementioned surveys, while initial jobless claims are expected to continue their downward trajectory to 1.3m (still high) from 1.54m in the prior week. Outside the US, market attention will be on Chinese May retail sales and industrial production figures (Mon) which are expected to show further improvements. In the Eurozone, the German June ZEW survey (Tue) is forecast to show a rise in current conditions to about -82 after dropping to -93.5 last month, although we think the expectations index may edge down to 43 after an exuberant rise to 51 in May. Finally, the Bank of Japan (Tue) is expected to keep its main policy measures on hold, including interest rates and yield curve control.
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See you next week!
None of the information in this article is, nor should be construed as financial advice. All foreign exchange transactions involve risk and you should always seek your own independent financial advice before entering into any foreign exchange transaction.
