The third quarter kicked off with consolidation equities and currencies. Stocks traded slightly higher while the US dollar edged lower, allowing sterling, the Canadian, Australian and New Zealand dollars to extend their gains. US coronavirus cases continued to rise at an alarming rate, a sign that the US government has very little control over the growing crisis. Yet investors continue to hold out hope that the death rate will remain low and a vaccine or treatment will be developed in the near future. Today, Pfizer (NYSE:PFE) released positive initial results from its early stage vaccine trial. As promising as that may seem, it is important to realize that only 45 people participated in that trial. There are other companies with vaccines in various stages of trial so the hope is that more promising news will follow. A vaccine doesn’t need to be developed tomorrow, the mere hope that one is right around the corner will be enough to invigorate market flows.
In the meantime, the focus shifts to the outlook for the US economy. Nonfarm payrolls will be released on Thursday this week instead of Friday due to the holiday and had there not been this recent surge in US cases and pause in reopening by major states, the prospect of a further labor market recovery would be very good for currencies and equities. Unfortunately, investors will look at the June data and worry about whether these gains can be sustained in the third quarter.
For traders, this means that a weaker jobs report should have a more significant impact on currencies and equities than a strong one. Economists expect a recovery of 3 million jobs last month with the unemployment rate falling to 12.5% from 13.3% and average hourly earnings dropping -0.8%. According to ADP 2.3 million jobs were added in June, which was less than expected. Challenger reported a 305% increase in layoffs. If job growth falls short of that, the unemployment rate worsens instead of improves or there’s major downward revisions to last month’s report, we could see a significant low liquidity sell-off in equities that drives USD/JPY, EUR/USD and all of the major currency pairs lower. Ugly numbers will trigger risk aversion by confirming that the recovery is not as strong as everyone hoped, making the next few months more challenging.
However, last month’s positive job growth was a big surprise as everyone expected job losses, so if these improvements are maintained with no major downward revision to the May report, investors will be relieved. We’ll see an initial rally in equities and risk currencies including USD/JPY. But the gains could fade quickly as investors realize these numbers could deteriorate quickly if states reverse reopening policies. The food service industry in places like Florida, California and Texas will take a big hit by the closure of bars and nightclubs. According to California Governor Newsom, new restrictions will be announced before July 4th as the state reports a record 9,740 new COVID-19 cases; restrictions are expected to include a 3 week closure for restaurants. The US economy is still deep in the woods and tomorrow’s reports will at best provide cold comfort in uncertain times. The steps taken by Governors like Newsom are necessary at the consequence of the recovery.
For all of these reasons we think any rally in currencies and equities should be faded. The Canadian and Australian dollars are the most vulnerable to weakness. The recovery in Canada has been slow and they will refrain from reopening their borders until the US gets a better handle on the COVID-19 crisis. Australia just announced fresh lockdown measures in the Melbourne hotspot, its second most populous city. Recent data was also mixed, with stronger manufacturing activity offset by a sharp plunge in building permits.