The Week Ahead - Heat Wave

Heat wave

Economic engines are firing again as the world climbs out from a deep, pandemic-induced recession. Accumulating evidence indicates the worst of the downturn occurred in April or May and that, as countries reopened, activity rebounded. Importantly, not only has economic data improved, in many cases the numbers are coming in stronger-than-expected. In fact, the early stage of the global recovery is starting to look similar to the V-shape that formed in financial markets in March.

What’s next? If markets are a guide, recent economic gains could slow. Since business reopening got underway in early June, the MSCI World Index has been range-bound, mostly moving sideways. At the same time, as consumers have returned to restaurants, hair salons, gyms and shopping malls, the pandemic has accelerated.

The viral resurgence has economic consequences. In recent weeks, restrictions have been reimposed in several European and Asian countries and 10 US states. Hopes for summer tourism have been dampened, as policymakers announce bans and quarantines on visitors from global hotspots.

It is critical to wrap perspective around what this means: targeted measures will hurt some companies and communities. But the overall economic impact should be less than it would be from renewed national lockdowns.

It is also important to keep in mind that economic growth is the intersection of supply and demand. Reopening brings the supply of goods and services back online. Demand – and consumer comfort about resuming activities – is the second half of the equation. From that standpoint, it is notable that a key consumer cohort – people over the age of 65 – are more likely to die from the virus and they spend a lot more money than their lower-risk under-25 peers.

This suggests that, leaving aside a potential vaccine or containment, the initial V-shaped economic recovery may transition into a longer-tailed process of structural repair. And the longer it takes to contain the virus, the greater the risk of permanent job losses, business closures, shifts in consumer spending patterns and policy fatigue.

The Week Ahead

The burning question today is whether investors are still too pessimistic about the economic recovery, or if the soft high-frequency data released recently might portend a risk of disappointment. (See our Chart of the Week). We’ll soon get answers.

The focus Monday will be manufacturing in the world’s two largest economies: the US and China. In both cases, consensus estimates suggest that July was yet another month of accelerating expansion. Conditions in the US, in particular, are forecast to reach the strongest level since April 2019.

On Tuesday, attention will shift to Tokyo, Japan, where July core consumer inflation is expected to hold at 0.20% year-on-year. Tokyo data typically gets published before national statistics and provides insight on the country’s direction.

Wednesday brings euro area retail sales. While consensus estimates point to a 15.8% month-on-month gain in June, the year-on-year rate is expected to weaken from -5.1% to -7.5%. Also, in the US we’ll get the July ISM service sector index, which is expected to ease from 57.1 to 55.0. While that’s still expansion territory (above 50), it shows prospective damage from the (re)closure of bars, restaurants and gyms, and persistent weakness in travel. Services account for about 70% of US GDP.

On Thursday, expect to see German factory orders plus a monetary policy decision in the UK. The Bank of England is forecast to hold interest rates at 0.25% and maintain its quantitative easing programme at GBP 725 billion.

The week closes with a heavy Friday calendar. In China, we’ll see July imports and exports, which are expected to contract 10.0% and 1.5% year-on-year, respectively. In Europe, Germany’s economic recovery will be in focus, with export growth expected to accelerate to 13.8% month-on-month and industrial production forecast to jump 10%. In the US, investors will decipher the July employment report, with consensus estimates pointing to another blowout 2.26 million jobs added and unemployment falling from 11.1% to 10.3%.

Reviewing risk-on

The “risk-on” reflationary trade continues to hold, with commodity prices improving while the US dollar weakens. Cyclical indicators are pointing toward a rotation, potentially offering further support for Europe’s bourses. In the US, technology stocks continue to provide leadership, shrugging-off brief bouts of weakness and rising concerns about stretched valuations. While the macro backdrop has become more challenging, technical trends suggest a continued overweight in commodities and equities.

Stay cool,

Greg

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