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Asia Open: Is it shaping up to be a reverse square root recovery?

Market Analysis - 6 Min Read Stephen Innes | 03 Jul 2020

Markets

US equities were stronger Thursday, the S&P closing 0.5% higher after a great beat on payrolls in June, though the less impressive jobless claims data soured the sweet mix. European equities fared better, with the Stoxx600 rising 2%.

Overall the report was good, but not too good, which suggests the Fed will remain accommodative for as far as the eye can see. With the re-imposing of soft lockdowns, the leisure and hospitality employees are likely to see further volatility in their employment status. That’s going to create a challenge predicting employment reports as re-closing will be an issue for further significant gains.

It would be tough to take the better-than-expected US June non-farm payrolls numbers and extrapolate that there’ll be a V-shaped recovery in the US; the economy has brought back only about 30% of the jobs lost.

The evolution of continuing claims as a critical metric also suggests the Fed will keep a steady hand. The higher frequency jobless claims number suggests the initial bounce-back has ground to a halt. Continuing claims were stronger than expected at 19.29 mn, compared with forecasts for 19 mn and after 19.23 mn. Initial claims were also a bit higher than the estimate.

On first blush, is it shaping up to be the reverse square root recovery?

There are two reasons why the knee-jerk price action of higher yields and a weaker dollar following the US June employment report faded and reversed. 

The NFP report is a mid-June snapshot, which might have been the "sweet spot" of near term employment optimism as the virus situation in the US has deteriorated sharply since. Also, the substantial jobs numbers may provide fodder to the Republican fiscal hawks to resist further budgetary support to be decided on later this month.

Both seem good reasons to dismiss Thursday's report in terms of a significant directional signal, though equities seem less bothered than bond desks.

This morning it’s not entirely clear what to make of yet another massive upside surprise in the US employment report. Still, with the weekend looming I suspect traders have the beach on their mind –(well maybe I do as I’m taking the family to Hui Hin to celebrate the July 4 and July 6-7 local holiday, masks in tow…).

May's NFP was a market mover, but for the June report I think we’re back in a place where the data won’t matter. With flare-ups in The South and the nascent re-opening not looking especially grand, the path of the virus and the re-opening are more critical than June jobs numbers. Universities and restaurants are a particular source of re-opening angst and uncertainty, even in virus cold spots such as NY, NJ and CT – even my colleagues in NY and NJ are expressing concerns about sending the kids off to university. 

Gold markets 

Gold shrugged off useful job data and, despite investor risk-on appetite, the yellow metal moved higher; gold has unwavering support from Covid-19 associated economic risks. Despite the recent run of market-beating data, gold investors remain more worried about the economy over the medium term, especially with geopolitical and trade concerns simmering on the back burner.

Gold's modest comeback ahead of the US holiday weekend is in itself an impressive feat. When good economic news becomes good news for gold, it ultimately points to underlying strength in bullion.

St Louis Fed President James Bullard stressed downside risks to the US economic outlook in an echo of recent Fedspeak, playing down signs of a cyclical recovery, in an interview with the Financial Times [paywall]. Put another way: the monetary policy will be left ultra-accommodative for the foreseeable future. As such, there’s little here that’s USD-constructive. 

These issues should be enough to support gold, especially as trade and geopolitical risks do not appear to be easing. Also, there’s enough return of inflation volatility getting priced in the market, and that in itself is more than enough cause to buy gold. 

Currency markets 

As ever, multiple cross-currents are weighing on the risk mood so the market's steady but upbeat tone this morning requires a selective approach to currency risk. But, given it’s Friday of a July 4th weekend – and considering whatever view we take this morning will likely be faded in London –when it comes to all things FX, wait until Monday.

The USD had yet another ambiguous relationship with improving US economic data. 

The USD could rally based on the improved outlook for the economy, or it could weaken based on a diminished safe-haven bid. The dollar’s final feedback loop to the non-farm payroll report offers no clear reaction function, just the fact that currency markets remain tethered to a hyperactive "risk-on, risk-off" yo-yo string. 

For the dollar bulls, in contrast to the US data on employment which is reverting the V-shaped attrition of March and April followed by the subsequent recovery, the Eurozone's unemployment rate has only nudged higher during the economic lockdown.

Trade for next week 

Regardless of the USD’s virus-inspired safe-haven appeal, I like the dollar lower. 

I realize my market notes have been tinged with USD "permabear" mode – which isn’t my usual style as I typically defer to only the data that matters – but years of practice tell me today it’s better to stick to a view and not over-compute in reaction to price action or marginal new information.

With the EU Summit on July 17, I think it's logical to stay bullish EUR until that date, and unless there’s some considerable news development or we trade to 1.15 too quickly (where my t/p sits), I'm in uber bullish EURUSD mode. 

The odds seem heavily skewed toward a European agreement and I think the market will price the positive outcome more aggressively as the date nears.

Malaysia and market’s love-hate relationship with the Ringgit 

Earlier this year most Ringgit traders assumed the worst for Malaysia as the currency moved to 4.40+. The country witnessed one of the earliest Covid-19 outbreaks in ASEAN, just as a new controversial government came to power – possibly one of the most toxic combinations a currency would ever have to endure.

However, policymakers moved swiftly to contain the virus with a lockdown via the so-called Movement Control Order imposed on March 18. The economic impact of the restrictions was severe but, crucially, the virus has so far been contained. 

Despite positive developments in recent weeks, the economic cost of the MCO was substantial. Fortunately, the fiscal and monetary and fiscal response was equally extraordinary. 

As oil prices continue to recover gradually from here on out – mind you not without a few bumps in the road and continued policy support from the BNM as Malaysia still has one of the highest real policy rates in the region at nearly 5% – there’ll be definite real yield appeal for the Ringgit as investors continue to chase yield returns. 

So, the MYR should continue to strengthen through July and into August when the BNM could cut interest rates after appraising the first run of high-frequency data prints for the second half and the all-important 2 Q GDP report out in August. 

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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