The third week of June kicked off with fresh losses for currencies and equities. There’s nothing more concerning to world leaders, investors and everyone for that matter than a second coronavirus wave. Unfortunately, those worries are becoming reality in many parts of the world. Here in U.S., new cases in Florida, Texas and Arizona hit daily record highs. Abroad, we’re seeing fresh outbreaks in major cities like Beijing and Tokyo. China’s decision to reinstate some lockdown measures has many worried that similar steps will need to be taken in other parts of the world. So far, China has locked down 11 residential compounds, shut down major food markets, banned inter-province tourism and delayed school reopenings.
The reversal in stocks began last week and it could mark a top for equities if the number of cases balloon. So far, the “officially” reported outbreak numbers in China and Japan have been small, but if they skyrocket to triple digits on a daily basis, China may decide that more severe restrictions with broader economic ramifications are necessary. If that happens, we will certainly see a deeper more durable sell-off in currencies and equities in which case AUD/USD and USD/JPY will be the most vulnerable.
In the U.S., Oregon, Utah, Nashville and Baltimore paused reopening. Members of the White House, from Vice President Mike Pence to Economic Adviser Larry Kudlow have dismissed the notion of a second wave, but the alarmingly sharp increase in case numbers in the Sun Belt signals a bigger concern. While a number of important economic reports are scheduled for release this week, including consumer spending numbers from the U.S., Canada and the UK, the main driver of market flows and risk appetite could be COVID-19 case numbers.
Expiring unemployment benefits could also lead to a more extensive slide in currencies and equities. Kudlow has indicated that the extra $600 a week unemployment benefit will not be extended when they expire next month. The Democrats want this benefit continued, but Republicans are resistant. Considering that this extra payment is keeping many families afloat, the economic impact could be devastating for millions of Americans. It would cut their incomes by a third and deal a major blow to summer spending. While there’s a very good chance the Democrats and Republicans will reach some type of deal that could include linking unemployment benefits to state unemployment rates, it won't be as generous as the current program. This poses a serious risk to the equity market rally and risk appetite.
With that said, U.S. data continues to improve with a much stronger than expected Empire State manufacturing index. Economists were looking for an improvement to -29.6 from -48.5, but instead of contracting, the data shows the sector stagnating in the month of June, with the index rising to -0.2. Investors will be eager to see if this strength and recovery carries over to retail sales, which are scheduled for release on Tuesday. This is the most important piece of U.S. data on the calendar, and spending is expected to rebound 8% after falling 16.4% the previous month. Between mid-May and early June, currencies and equities rallied on the prospect of recovery, and now we’ll get a chance to see just how strong these recoveries have been. Lockdown measures led to depression-like economic activity in March and April. But once lockdown restrictions were eased, pent up demand should boost spending. The only question is the magnitude of the recovery. If retail sales rise 10% or more, we will see a recovery in equities and currencies. However, if spending falls short of expectations, the meltdown will continue. U.S. retail sales will be far more important than the Bank of Japan meeting, where the central bank is widely expected to leave rates unchanged.
Investors should also keep an eye on the euro and sterling. The German ZEW survey will be released tomorrow and further improvements in investor confidence is expected. Meanwhile, the Bank of England will be the only major central bank to ease monetary policy this week. Its decision will be motivated, in part, by Tuesday’s labor market numbers. While May was a month of fewer job losses, the PMIs suggests that labor market conditions remain weak. Therefore, sterling is the most vulnerable to losses this week.