06/09/2021 - WEEKLY MARKET REPORT


Weekly US employment report dents dollar, puts Federal Reserve in a bind


The Federal Reserve cannot be happy with the US payroll report for August.


Weaker than expected employment growth shared the headlines with strong wage gains, suggesting that inflationary pressures will not be as transitory as it hopes. The US dollar promptly sold off even as US yields rose, a reversal of the usual correlation between the two. Risk assets put in a mixed performance last week.


Commodities rose strongly to a fresh five-year high, pulling emerging market currencies with them, in a further sign that inflationary pressures are not abating. Equities had a rougher time, dragged down by the downbeat payroll report. The unambiguous loser of the week was the US dollar, down against nearly every major currency.


With the end of the holidays, focus now shifts to the major central bank meetings in September, led off by the ECB on Thursday and the Fed in a couple of weeks. The unusual stagflationary tone of the most recent macroeconomic news, particularly the US, makes it particularly hard to predict how policymakers will react. We expect at least some spirited debate within the ECB council, though it is not clear the consensus is there yet to start reducing the monthly PEPP purchases of sovereign bonds.



GBP


Data out of the UK suggests that the economic recovery is on track there, and markets are expecting a strong July monthly GDP number this week. However, the Bank of England will also have to deal with the global dilemma posed by strong inflationary pressures in spite of reasonable labour market slack. We think that market expectations for reductions of sovereign bond purchases and future hikes in the UK are too dovish, and look forward to the September MPC meeting as a potential catalyst for a sterling rally.


EUR


The flash inflation report in the Eurozone provided yet another disagreeable surprise. Headline and core components both rose strongly, and the increase can only partially be attributed to one-off factors. It seems clear that the ECB will face the same conundrum as the Federal Reserve: how to deal with persistent inflationary pressures even though labor markets have yet to return to pre-pandemic levels. This week's meeting will be finely balanced, and we expect at the very least to see the beginning of serious dissensions

within the council, which could be supportive of the common currency.


USD


The US payroll report carried a distinctly stagflationary odour, with a disappointingly low job-creation headline coupled with a strong gain in wages. While the latter would be welcome in general, we should note that these increases continue to lag most inflation measures and that in real terms we have seen so far wage reductions overall.


As in the ECB's case, we continue to expect the debate within the Fed to intensify, as it becomes increasingly unclear whether additional monetary stimulus will do more good than harm in these circumstances. Regardless, the fall in the US dollar in spite of rising yields is more easily explained in a stagflationary context.


CHF


The Swiss franc continued on a downward trend last week, ending it as the worst-performing G10 currency. Improved risk sentiment following the Jackson Hole meeting continued into the week. Rally in EM and high-beta currencies was given an additional boost by disappointing economic data from the US, with investors favouring riskier investments instead of safe-haven currencies.


Last week’s economic releases from Switzerland were mixed. GDP disappointed somewhat, growing by 1.8% in the second quarter from the previous one. Inflation, on the other hand, surprised to the upside in August, reaching 0.9%. Although it reached the highest level since late-2018 and on month-over-month basis price growth has been positive for all but one month so far in 2021 we think it’s unlikely to yield any change in tone from the SNB, particularly considering that on balance, the franc remains relatively strong, which works against higher prices.


AUD


The Australian dollar rallied by another 2% or so against the US dollar for a second straight week, ending it as the second-best performing G10 currency. Improved risk sentiment, weaker USD, and largely better-than-expected domestic economic data supported the rally. At the same time, worrisome PMI prints from China and deteriorating domestic coronavirus numbers were largely ignored. They do present some downside risk to the currency, although a recent switch in the country’s strategy away from the Covid-zero to ‘living with Covid’ boosted by a surge in vaccinations limits this downside.


This week the attention turns to the Reserve Bank of Australia meeting on Tuesday. The key for the markets would be whether the bank decides to delay its planned scaling back of bond purchases to A$4 bn from A$5 bn which was supposed to start this month. There are good arguments in favour of both delaying and proceeding with the taper and there is no clear consensus, which suggests that any decision will likely be market-moving. We see more risk to the downside for the AUD this week, considering the recent rally coupled

with risk related to the RBA meeting could result in profit-taking even prior to the decision.


We now think there’s a somewhat higher chance of a taper delay than moving forward with it, particularly as the risk of Covid-induced slowdown in both Australia and its largest trading partner is materialising and uncertainty regarding the future could push the policymakers to err on the side of caution.


CNY


The Chinese yuan strengthened again last week, reaching the strongest position against the US dollar since mid-June as the market sought risk and largely ignored disappointing prints from China’s economy.


After a decline of official PMI indices came similar yet perhaps even more disappointing Caixin prints suggesting that the slowdown in activity in August was broad-based, seen in large state-owned companies and smaller private companies alike. The services sector data was particularly worrisome as both NBS and Caixin indices ended up few points below level 50 pointing to contraction in the sector making up approximately 55% of China’s GDP.


It seems to be a reflection of the stringent measures the country adopted to ensure COVID

spread is limited, which, for the most part, still remain in place casting a shadow on economic activity.


This week’s domestic economic calendar is rather light. Thursday’s inflation print for August is likely to catch limited attention, barring significant surprises.



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