The US recovery is V-shaped

Outlook

This is a data-packed week, with US GDP on Thursday and PCE inflation on Friday, and before then, the Fed policy meeting tomorrow and Wednesday.

We have a weird relationship between standard fundamentals, including yields and their built-in inflation forecast, and perception of risk. Risk is increasingly a function of alternating vaccine euphoria (the reflation trade) and Delta Panic. There is also a dollop of foreign affairs in the risk equation, with China getting touchy about its standing and prestige in the world and throwing curveballs like cracking down on companies listed in the US.

We just saw a bit of panic in Australia, where severe lockdowns delivered a big drop in the PMI’s and in the Australian dollar on the idea the Reserve Bank will be less hawkish. The UK has completed its lockdowns and has a high vaccination rate, and is getting a robust recovery and a rising currency. The US has an inadequate vaccination rate (only 49%) but ongoing chatter that the Fed will give a tapering date at this week’s policy meeting or perhaps Jackson Hole.

We guess the Fed is not going to do any such thing. It can see the Covid case load and US vaccination rate along with everyone else, and since it says it will act only when hard data has been delivered, the Fed will wait for hard data. In other words, the unexpected Delta phenomenon has thrown a monkey wrench into the Fed’s timetable and if it had intended to prepare the market with a hint of tapering this week, now it’s not.

We are all too likely to get another Delta Panic, and when it comes, we will see safe havens like the dollar, yen and Swissie benefit. The case for safe havens lies mostly in the likelihood of Delta getting out of hand and also more variants in the works, like Gamma. We need to watch that case chart and also the stalled vaccination initiative. Vaccinations are not 100% effective against Delta and presumably other variants, but a whole lot better than going unvaccinated.

Alternatively, maybe we take it as given that the pandemic is ending and the Delta wave is killing proportionately so few that we have a New Pandemic Normal. That new normal entails recovery in supply chains, chip production, and transportation costs (as well as health care services costs), reducing inflationary pressures. Those transitory components of inflation are the culprits driving up inflation, like those used car prices, not the standard components.

This new normal is what the Fed embraces, and the big bank and fund manager economists are buying it. Unless Delta gets really wild in the US, we can expect inflation to be transitory and US growth to resume. And note that lockdowns, quarantines and other stringency measures are far more prevalent in other countries than in the US. Basically, Americans have washed their hands of stringency and are not going to take it anymore. And since Delta makes you sick but for the vaccinated, doesn’t actually kill you, the consumer can proceed with pre-pandemic habits and norms. The US recovery is V-shaped.

The point of the V can be very sharp. The new normal includes sending kids back to school and liberating half the population from self-imposed quarantines. Schools are re-opening in August this year to try to make up for lost time; parents are already getting a hefty child-care subsidy, and vaccines for children are expected in September. By October we should see a gigantic rise in employment, and that’s what the Fed cares about. That will feed the non-transitory inflation components but if the transitories are falling as expected, maybe the Fed can pretend they are a second kind of transitory, the re-opening kind.

The sticking point in this scenario is manufacturing production in Asia, all of Asia–China, India, S. Korea, Taiwan, Japan and anywhere else that makes semiconductors and related stuff like batteries. Delta must be restrained/contained/vaccinated down to allow output of those central goods to recover. Without them, Western manufacturing and jobs fail. Is it really that simple? Yes. We worry about Delta in Latin America, which with Africa is getting half the donated vaccines, but for raw self-interest with no humanitarian consideration, the US and others should be sending them all to the Asian chip-makers.

Bottom line, if the WSJ is right and the US stock market rally is led by foreigners buying US equities because they perceive the US recovery as stronger and more long-lasting than elsewhere, then we have no need for the yen and Swiss franc safe havens. The charts may reflect this, too. We are on the cusp of a reversal signal in the dollar/yen (to buy USD), albeit with no good inputs on how the Olympics are affecting sentiment. We already have a buy signal in the USD/CHF but it’s wobbly–the dollar is gyrating/hovering around the 50% retracement of the move down from the recent high on April 1. Note that the COT report shows a cut in long yen holdings and a rise in Swiss positions.

The dollar gets a boost from a rise in risk-off as a safe haven. It gets support from risk-on as the leader of the reflation trade growth narrative. But right now it’s betwixt and between, and we don’t like it–a breakout can come either way.

Inflation Summary: The WSJ has a dandy comparison of inflation expectations from the top sources. For consumers, the University of Michigan has 4.8% in the 1-year but 2.9% in the 5-10 year outlook, down from 3% in May.

For bond investors, the 5-year breakeven rate dropped 0.19% since mid-May. “Moreover, since January the five-year break-even inflation rate has been higher than the 10-year rate, the first time that has happened consistently since 2008.” Oxford Economics says this means near-term inflation is going to ease.

Businesses see inflation dropping, too. Thew Atlanta Fed’s business inflation survey shows companies expect 2.8% inflation a year from now. Down from 3% in June. This is costs to businesses, not heir selling prices.

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This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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