Stranger Things

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As November bleeds into December, new high-frequency data will be incorporated into an investment climate that is being shaped by the public and private response to the coronavirus. At the same time, the long drawn out game of brinkmanship between the UK and EU continues.

The only deadline that seems inviolable is the termination of the standstill agreement at the end of the year. The trajectory of monetary, fiscal, and dollar policies of the incoming Biden administration in the US is also influencing the business and investment outlook.

Let's begin by looking at the economic highlights in the week ahead. The flash PMI estimates do such a good job of anticipating the final report that little new information will be available with this week's reports. Some more emerging market country PMIs will be available and reports on a few peripheral European countries will be published, but the general picture will not change much.

The recovery in the Asia Pacific region appears to be solidifying and broadening. Europe has been hit hard by lockdowns, curfews, and social restrictions, which will likely extend into next year in some countries. The risk of a contraction in large parts of Europe looks likely.

Social restrictions have been less severe in most of the US, and the recent string of economic data, including the flash PMI, shows a fairly resilient economy. If anything, the firm consumption, strong capex, and inventory rebuilding figures are lifting forecasts for Q4 GDP. Of course, it cannot compare with the 33% annualized jump in Q3. Still, growth is looking to be more likely in the 4-5% area, which is still well above trend.

For the US, the November employment data is the most important data point. Bloomberg's survey median forecast calls for around a 500 thousand increase in nonfarm payrolls compared to a little less than 640 thousand in October. By nearly any metric, this is a strong number, and that includes a nearly 100 thousand loss of government positions. Manufacturing hiring is forecast to have accelerated from 38 thousand to 47 thousand. The unemployment rate, imputed from the household rather than the establishment survey, may slip from the 6.9% rate.

The price of the US economy's resilience may be a more prolonged and deadly wave of the virus. It may not be clear for several weeks. At the same time, it faces two fiscal cliffs. The first is the government's spending authority, which ends on December 11. The Republican leadership in the Senate and the Democratic leadership in the House have agreed to the broad outlines of an omnibus appropriations bill.

However, it is likely to meet some resistance from some who want to enforce past spending caps. At the same time, the devil in the details includes funding for the controversial wall on the Mexican border and other specific allocation of funds that are likely to be disputed. 

The other fiscal cliff is the expiration of emergency jobless benefit programs that assist around 12 million in the coming weeks, beginning the day after Christmas. At the same time, the prohibitions against foreclosures and evictions will also expire at the end of the year unless there is fresh action by Congress and the Trump administration.

Student loans will have to be serviced again. This cliff can be a $150 billion blow in Q1, and some economists have warned of a possible contraction. There may be an attempt to renew some income support programs in the appropriations bill. It is not clear yet. Investors seem confident that more fiscal stimulus will be provided, but the run-off elections in Georgia in early January will likely determine the size and scope. 

Japan and the eurozone also reported employment figures, but they do not have the same market impact as the US jobs report. The takeaway is that while the US unemployment rate is falling, it is still rising in Europe and Japan. Both are expected to post new cyclical high levels of joblessness.

Japan's unemployment rate is expected to tick up to 3.1%. It was at 2.2% at the end of last year. Last week, Tokyo announced that its job subsidy program will be extended through February. The eurozone's unemployment rate has been stuck at 8.3% in August and September, and is forecast to have risen to 8.5% in October. The unemployment rate had fallen to a euro-era low of 7.2% in March.

The preliminary November eurozone CPI will draw more attention, but it is unlikely to change market views much. Deflationary forces remain evident, though the ECB still prefers to talk about disinflation, which means low inflation. Yet, the headline CPI is expected to have remained below zero on a year-over-year basis. The difference between -0.3% in October and the anticipated -0.2% in November is hardly worth debating.

The core measure is expected to have remained unchanged at 0.2%. There are several drivers, including weak growth/spare capacity, the decline in oil prices (Brent is off more than a quarter year-to-date), and a number of schemes, including a temporary cut in the VAT and other sales-promotion efforts. The euro has strengthened against all of its trading partners, which is also a deflationary force. 

The Reserve Bank of Australia begins the next round of central bank meetings. It delivered a 15 bp rate hike and announced more QE (A$100 billion of 5-10 year bonds) at its last meeting, and is not expected to take fresh action. Australia will also announce Q3 GDP, which is expected to have expanded by around 1.8% after Q2's 7.0% contraction.

The social restrictions in Victoria may have halved growth. Canada's Finance Minister Freeland will provide a fiscal update, which is expected to flesh out Prime Minister Trudeau's Throne Speech in September that committed the government to counter the virus's impact. Before the new initiatives, the deficit-to-GDP is among the largest in the G7, just shy of 20%.

The OECD will update its forecasts, which, like the IMF's World Economic Outlook, offers a general overview. While economists tend to pull it apart, the broad aggregate view provides a good benchmark and base case. It is the OPEC+ meeting at the start of the week that is more likely to spur a market response.

Even with the vaccine developments, a cloud of uncertainty still casts a shadow over the outlook for demand. While an extension of the current cuts seems more likely than sticking to the initial plans of boosting output by 1.7 million barrels a day in January, the more than 30% rise in prices since the start of the month may weaken resolve.

The tone of official comments around Brexit negotiations has taken a turn for the worse. France has accused the UK of dragging its feet, and EU President von der Leyen, who previously was optimistic that a deal could be reached, is now less certain. Reports suggest the EU's chief negotiator Barnier has told the UK's chief negotiator that he sees no point in going to London next week unless Frost is ready to compromise.

There are procedural moves that the EC could take to allow a later or expedited ratification process. Perhaps one of the most frustrating aspects of these dragged-out talks is that a solution is clear to many outside observers. First, on fisheries, the proverbial can could be kicked down the road. A one-year standstill arrangement would prevent it from blocking the larger trade deal. Second, as we have noted in the trade agreement with Japan, the UK has made the concession the EU sees on state-aid. Third, there are numerous dispute resolution mechanisms that both the UK and EU familiar with and have experienced.

With nearly every passing day, it appears US President-elect Biden will govern from the center of the Democratic Party. The appointments are clearly in that direction. Many of the appointments are familiar faces from past Democratic governments. During her illustrative career, Yellen has been a hawk and dove, in favor of fiscal stimulus and an advocate of restraint. Context matters. 

In the current context, Yellen favors larger rather than smaller fiscal stimulus. She recognized before many of her peers that lower unemployment does not in itself have to spur inflation. Yellen appears to have drawn the lesson from past crises that the real risk is ending support too early rather than too late. Yellen is part of the traditional internationalist political elite's return after the unorthodox Trump years. She will have to navigate the economic nationalist forces that will also be represented in the new administration. 

Around a quarter of a century, after Rubin enunciated the "strong dollar" policy, there is still much confusion. It was not about the particular exchange rate, but a pledge to investors, both public and private, domestic and foreign, that the US would not purposely seek to devalue the dollar to reduce its debt burden or for trade advantage.

This represented a sharp break from the Reagan-Bush and early Clinton years. What it meant in practice, and as embraced by the G7 and G20, is that foreign exchange levels are best set by the markets. It is similar to an arms control agreement.

As an accomplished economist, Yellen is likely to place less emphasis on bilateral trade imbalances. She recognizes that the US trade deficit cannot be blamed on China (and Germany) as it has become the most recent American exercise in blaming others for its problems. Of course, this is not to deny, and Yellen has not, that a strong dollar may dampen growth and inflation while exacerbating the trade deficit.

Typically, it is desirable for the currency to move in the direction of policy. As Fed chair, Yellen was quite cognizant that Treasury sets dollar policy. As Treasury Secretary, she is likely to find her own way of reaffirming the commitment not to use the dollar as a weapon. Access to the dollar funding market is a different matter. US sanctions have proven to be a powerful lever, but the extensive use encourages workarounds.