Markets were in risk-off mode for much of last week, as concerns rose that the ongoing rebound in global growth will be less pronounced than anticipated. The decision by the People’s Bank of China to loosen monetary policy for the first time since April 2020 drew outsized attention in this regard, as officials moved to kickstart slowing Chinese GDP growth. Given China is further along the path to recovery, this spooked traders and led to them questioning whether they were too optimistic about the economic outlook in western economies.
While a slowdown in China would have negative implications for global growth, with the export-oriented eurozone particularly vulnerable to adverse spill over effects, it is not clear to me that China offers a reliable guide for how recoveries will progress elsewhere. In contrast to western economies, China’s rebound has largely been export and investment focused. Exports are still holding up reasonably well (+23.4% on 2019 levels as of May), but the outlook for investment has deteriorated as officials have sought to curtail credit growth. At the same time, China has struggled to kickstart consumer spending as the government neglected to introduce the sort of income support schemes (be it furloughing programmes or enhanced jobless benefits) rolled out in Western economies in response to the crisis. As a result, despite largely re-opening over Q320, Chinese retail sales were up just 8.0% in May on their May 2019 level (sales in the US were up 20.7% over the same period).
In contrast to China, the recovery in western economies is all about the rebound in household spending. GDP data for Q221 are not yet available, but the breakdown looks set to be similar to that of Q320 when consumption accounted for roughly 70% of the surge in UK output growth following the easing of the first lockdown. Consumer sentiment data suggest that household spending will remain robust in the coming quarters, with confidence levels soaring as vaccine rollouts have allowed economies to re-open, boosting spending opportunities and prompting a marked improvement in labour market conditions. A further tailwind relates to the significant stock of excess savings that households have been able to build up thanks to the rollout of income support schemes. In the UK for instance, these savings are worth up to 10% of GDP and per Bank of England research, circa 30% of these savings will be unwound over the coming year.
Granted, UK consumer spending data have also showed signs of softening recently, as a combination of looser restrictions and the more transmissible delta variant have seen cases surge. However, with studies showing that vaccines have retained their effectiveness (link between hospitalisations and infections has been substantially weakened), the current slowdown is likely to represent a mere blip in the road to recovery. The key headwind now is self-isolation rules, with 600k ordered to stay at home in the week to June 30. However, the requirement to isolate for those vaccinated will end on August 16 (if they test negative), which alongside a further easing of rules on ‘Freedom Day’ on July 19 should allow for an acceleration in household spending later in Q321. Similar dynamics will likely be at play in the eurozone and US, though on a slightly lagged timeline given that the delta variant is only now taking hold in both regions.
So what does this mean for currency markets? Looking to the medium-term, as the delta variant driven surge in cases subsides and China’s move to boost growth begins to bear fruit, I expect to see a recovery in sentiment and an associated reversal of risk-off driven gains for the dollar. Sterling is particularly well-positioned from such a development, given that the UK’s significant current account deficit leaves the currency quite vulnerable to shifts in risk appetite. In the near-term, however, the dollar is likely to remain well supported as long as doubts over the extent of the rebound persist.
With questions being raised over the Fed’s commitment to see through the current period of elevated price pressures in the US, all eyes are on the release of June CPI figures on Tuesday. The data will be closely watched for any signs of an easing of inflation, with consensus anticipating a modest slowdown in the m-o-m rate from 0.6% to 0.5% (y-o-y rate: 5.0% to 4.9%). Risks to the forecast are tilted to the upside, given recent ISM survey data suggest that major supply chain issues are continuing to push producer costs higher and elevated demand is making it easier for businesses to pass these costs onto consumers. I expect that the release will see the dollar remain well-supported, but it may be difficult for the greenback to push significantly higher (cable to $1.37) given the aggressive path for Fed policy tightening already priced in by markets. In fact, for this reason risks are arguably tilted to the downside, with a more pronounced easing in the m-o-m inflation rate possibly providing the catalyst for cable to consolidate around the $1.39 level.
Later this week, US retail sales for June will also be of some interest. A modest 0.2% m-o-m increase is anticipated, though Amazon’s Prime Day held on June 21 poses some upside risk. Data came in on the soft side in both April and May, as stimulus cheques sent out in Q1 resulted in spending being brought forward. The re-opening of the economy has also emerged as another headwind to retail sales growth, as consumers have increased spending on services relative to goods. Paradoxically, a negative print this week could see the dollar make some gains as it would strengthen claims that growth peaked in Q1 and that economists are overestimating the extent of the recovery everywhere.
CPI inflation figures for June will also feature in the UK, with a modest increase in the y-o-y rate from 2.1% to 2.2% projected. Card spending data suggest that demand side pressures appear to be easing slightly. However, I don’t anticipate that this will feed across into more muted price growth, given the slowdown is largely a function of a surge in Covid-19 cases that is pushing up costs for businesses as they battle staff shortages and deal with supply chain issues. Price pressures will continue to build through H221, with the Bank of England projecting that inflation will hit 3.0% following the partial reversal of a temporary VAT cut for the hospitality sector from end-September. However, the central bank has indicated that it will not move to tighten policy in response to what it views as a transitory increase in inflation, which raises the bar for a positive surprise this week to generate any meaningful upside for sterling.
The ONS will also publish the Labour Market Bulletin for the three months to May on Thursday morning, though the data remain distorted by the Job Retention Scheme. Unemployment is projected to have held at 4.7%, though the rollback of Covid restrictions in May (in-door hospitality re-opened) suggests we may see a modest dip in the jobless rate. The headline figure, however, fails to account for the 5% of the workforce that are on furlough and thus paints an overly optimistic picture of labour market conditions. Sterling is unlikely to prove reactive to UK labour market data until the expiration of the JRS in September, when the data will begin to show whether the timeline for BoE interest rate hikes priced in by markets is too aggressive (lift-off currently expected by mid-2022).
There is little out this week to influence the euro, with eurozone industrial production figures for May the only item of any note on the calendar. The figures are unlikely to be a mover for the single market currency, despite a likely weak print as supply chain disruptions persist, given that national figures from the eurozone’s three largest economies (Germany, Italy and France have already been published).
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