Stocks retreat before ECB, US + UK jobless numbers in focus

Morning Note

European stocks pulled back a little after a rally in the previous session as upward pressure on equities continues to hold firm despite rising case numbers as hopes for a vaccine are the new hopes for a US-China trade deal. Moderna has reported encouraging results from initial trials, while there is a lot of hope being pinned on AstraZeneca’s phase one trials, results of which are due to be published July 20th.

Whilst nothing is certain, it seems things are moving in the right direction for a vaccine to emerge by next year.

Shanghai fell 4% and Hong Kong was down almost 2% overnight after a mixed bag of Chinese economic data. US stocks rallied yesterday with the S&P 500 posting its highest close since the June peak, though futures point to the index opening around 20 points lower. The Dow is seen opening about 200 points lower.

UK jobless data reveals first wage drop in six years

The number of employees on payrolls in the UK fell by 650,000 between March and June, but the worst of the employment is still in front of us. Vacancies are at their lowest level since records began in 2001, earnings fell for the first time in six years, and the ONS noted that the standard definition of unemployment does not include half a million employees temporarily away from their jobs specifically for coronavirus-related reasons, who are receiving no pay while their job was on hold.

Unemployment claims were better than feared but we can pin this on furlough schemes which are extending the pretence, delaying the worst and providing a soft landing; but the jobless numbers clearly do not reflect the true extent of what’s coming. Meanwhile the number of hours worked – a key metric for the nation’s productivity – has collapsed.

China GDP rebounds, consumption lags

Chinese GDP grew 3.2% in Q2, up from the –6.8% contraction in Q1, which was better than forecast, albeit we apply the usual caveats about Chinese economic data. Industrial production rebounded 4.8%, but retail sales were down –1.8% vs an expected +0.3% improvement.  Richemont flagged a strong recovery in China despite sales globally falling 47% in its first quarter, with luxury goods stocks weaker. Burberry shares fell another 3%.

US data was solid enough, with industrial production +5.4% in June whilst the Empire State manufacturing index hit 17.2, a beat on the 10 expected and a big jump from the –0.2 in the prior month. It remains to seen however to what extent the rate of change in the recovery turns lower as data starts to reflect the ‘second wave’ of cases and the imposing of some fresh lockdown restrictions in some key states.

In the Fed’s Beige Book, the Dallas Fed noted that while the outlook has improved, the upward trend in new COVID-19 cases has increased uncertainty. “Economic activity increased in almost all Districts, but remained well below where it was prior to the COVID-19 pandemic,” the national summary read.

US-China tensions are bubbling away – plans by the White House to impose travel restrictions on millions of Chinese Communist party members is the latest in the saga.

Goldman Sachs earnings crushed expectations with a stunning quarter of trading revenues. Bond trading revenue jump 150% to $4.24bn, while equities trading revenue climbed 46% to $2.94bn. For me all it did was underscore the divergence we are seeing between the real economy and the market, which is benefitting hugely from two-pronged monetary and fiscal stimulus.

Oil still rangebound after OPEC agrees to begin tapering production cuts

Oil couldn’t break free from its narrow range as OPEC+ extended cuts but began tapering with production curbs in August down from 9.7m barrels per day to 7.7m bpd, although the total effective cuts will be around 8.1m-8.3m barrels a day as countries which overproduced in May and June would make additional compensation cuts in August and September. OPEC will need to play this carefully – the longer its barrels are off the market the more it could encourage higher cost US oil to come back on.

Inventory data from the States was bullish with the –7.5m drawdown much higher than the –1.3m expected. Gasoline inventories also fell by more than expected at –3m. WTI (Aug) rallied from the medium-term trend support around $39.20 yesterday to press on the $41 handle but it continues to lack momentum – the CCI divergence on the daily timeframe chart points to the rally running out of legs and buyer exhaustion that could call for a further pullback.

In focus today: ECB, Netflix, US jobless claims and retail sales

Lots coming up today…

ECB meeting: Following the top-up to the PEPP programme in June to €1.35tn, the European Central Bank should be keeping its powder dry with the key EU summit starting tomorrow to hammer out the budget.

I expect Christine Lagarde to stress the importance of the fiscal side and leave policy unchanged but stress that ECB’s accommodative position – this is not the time for a discussion of tapering or the details of how much of the envelope you need to use.

In a recent interview she said the central bank had ‘done so much that we have quite a bit of time to assess [the incoming economic data] carefully’. The EU recovery fund is more important for EUR crosses right now – agreement this week may push EURUSD beyond the key 1.15 level.

Netflix earnings: The ultimate stay-at-home company, Netflix (NFLX) has made hay in the pandemic, with the stock hitting an all-time high and clearing $520. In the March quarter, Netflix added 15.77m new subscribers, which was more than double the original forecast of 7m net adds.

The company has forecast 7.5m new adds in the June quarter and may easily beat this with around 10m subscriber additions.  Sequentially lower net adds should not weigh on the stock given the exceptional performance in the first quarter. ARPU could benefit from a depreciation in the dollar since it last reported.

As Netflix itself noted in its Q1 report, there is a lot of unknown to its forecasts. “Given the uncertainty on home confinement timing, this is mostly guesswork. The actual Q2 numbers could end up well below or well above that, depending on many factors including when people can go back to their social lives in various countries and how much people take a break from television after the lockdown.”

The market expects $6.1bn in sales and EPS of $1.8, with paid subscribers to hit 190m.

US weekly unemployment claims: Last Thursday’s data was better than expected for the week ending Jun 27th, however the total number of people claiming benefits in all programmes, including both regular state and all others, and including Covid-related programmes, rose 1.4m to 32.9m in the week to Jun 20th.

Initial claims today are seen falling again to 1250k from 1314k the previous week, with continuing claims seen down to 17500k from 18062k last week.

US retail sales: Expect to see continued improvement as the economy recovers off the lockdown lows. Retail sales should print another strong reading as consumers binge on their $600-a-week stimulus checks, which are due to finish this month.

ECB preview: Welcome to Japan?

Equities

The European Central Bank (ECB) convenes next week (June 4th) and is expected to increase emergency asset purchases as it continues to show it will ‘do whatever it takes’. With the scope of the Covid damage becoming a little clearer and deflation rearing its ugly head again, the ECB will stick to the old playbook of more QE to fight it. As ever the market will wonder whether this is ‘enough’, and as ever the answer will come back in the negative.

ECB monetary policy outlook: Japanification?

Eurozone inflation sank to its weakest in 4 years in May, data on Friday showed, only making further expansion by the ECB all the more certain. HICP inflation declined to 0.1% for the euro area, but outright deflation was recorded in 12 of the 19 countries using the single currency. Things have changed a lot since Mario Draghi declared victory over deflation in March 2017.

Nevertheless, core HICP inflation remains stable at 0.9%, which will give some comfort to policymakers. The decline in the oil price passed through to petrol pumps, with energy –12% year-on-year.

Recovery in oil prices should boost the headline reading going forward but the core reading may not be able to withstand the pressures of demand destruction and mass unemployment. The reading today only means the ECB will keep its foot to the floor with increased asset purchases.

However, in reality, given the ECB is already at the absolute limits of monetary policy efficacy, it cannot actually do much about this and only hope that consumer confidence comes back and for energy prices rise – and for global money printing efforts by central bank peers to stoke a round of inflation, which some think will be the outcome post Covid-19.

The concern of course is that Europe, like Japan, has driven itself into a vicious cycle of deflationary tendencies and negative interest rates that will be very hard to escape, particularly as it contends with long-term, perhaps permanent, damage to productivity and economic activity due to the pandemic.

Eurozone economic projections

There will be a lot of focus on the staff macroeconomic projections, although the extreme uncertainty around the extent of damage to the Q2 readings and speed of recovery forecast for Q3/4 means a lot of this remains guesswork.

The ECB has detailed three scenarios for GDP in 2020 relating to the damage wrought by the pandemic: mild -5%, medium –8% and severe –12%. Various comments indicate we can now rule out the mild scenario. Christine Lagarde said this week that the “economic contraction likely between medium and severe scenarios”, adding: “It is very hard to forecast how badly the economy has been affected.”

There is no way of really know how badly Q2 went. We have various sources estimating pretty seismic falls; INSEE says French GDP will contract by 20% in the second quarter. Estimates for Germany suggest a roughly 10% decline.

We know that tough lockdown measures that started to be introduced across Europe in March produced a noticeable impact on Q1. Whilst economic activity is emerging from the cold again as June begins, there is little doubt that April and May saw considerable declines in output.

More PEPP announced after the ECB monetary policy meeting?

The ECB seems all but certain to increase the size of its Pandemic Emergency Purchase Programme (PEPP). The €750bn limit looks likely to run out by the autumn and the ECB will want to push the envelope by a further €500bn.

Germany’s Constitutional Court ruling has obvious repercussions for the Bundesbank, but that ruling relates to ‘normal’ QE and not PEPP, which would tend to argue in favour of expanding this programme now during the emergency, rather than trying to top up later on.  Moreover, the ECB wants to make sure that the ‘whatever it takes’ message gets through to the markets to avoid dislocations in bond markets.

Finally, whilst our focus is on the ECB in the coming days, the most important thing for the EZ and the euro is not Ms Lagarde and co, but the frugal four and the EU’s rescue fund. The European Commission’s 7-year budget including the €750bn rescue fund were only published this week so a final decision is not expected any time soon.

Budget talks look set to be long and arduous – the numbers of budget contributors highlight that Sweden, Denmark, Austria and the Netherlands pay their fare share and some: all contribute more than 3% of GDP vs 2.2% by France and 3.9% by Germany. Which is why Germany throwing its weight behind the bailout grants (as opposed to loans) is so crucial. Ultimate the EU will work out a fudge to keep the frugal four on board- the question is whether it can somehow achieve debt mutualisation and make its ‘Hamiltonian’ moment real.

EURUSD chart analysis

The dollar was offered on Friday with DXY sinking to its weakest since mid-March and test the 61.8% retracement of the Covid-inspired rally at the 98 round number support.

This helped push EURUSD higher as the pair cemented the breach of the 200-day simple moving average on the upside. Bulls looking to take out the late March swing high at 1.1150, which could open up a pathway to the 50% long-term retracement at 1.1450.

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