Recovery in full swing but reopening now vital

The sense that the end of the Pandemic is close received something of a reality check yesterday as data showed that consumer spending was a drag on the economy in Q1.

GDP fell by 1.6% during the first three months of the year. This was more than expected as the effect of the lockdown bit into activity. The list of sectors that were worst affected is obvious, with wholesale and retail trade, accommodation and food services taking the biggest hit.

The economy now stands 8.8% lower than it was in Q4 of 2019. Most analysts consider the data that was released yesterday as ancient history, but it serves to show that the economy still has some way to travel.

The start of July comes with the knowledge that from today the Government’s furlough scheme will begin to be wound down. This is seen by many as the acid test for the resilience of the recovery and the ability of firms most badly affected by the restrictions to bounce back.

It is fairly obvious that firms that still have workers on furlough will need to take a long hard look at the viability of their business, since they will now have had up to fifteen months of reduced or complete inactivity.

There will be a fiscal headwind facing businesses who have to start to find the cash to contribute more to their idle employees’ wages.

While the success of the vaccination programme is undoubted, the fact that we will need to live with Covid for an extended period means that being able to keep hospital admissions to a minimum will be vital.

The stamp duty holiday also begins to be tapered from today. The effect on both the volume and price of transactions will be closely studied, as this will also be a drag on Q3 GDP.

The pound fell again yesterday as the dollar index continued to climb.

It reached a low of 1.3798 but bounced back on profit taking to close at 1.3831. The 1.3780 level now looks critical on daily charts and with the NFP due in the U.S. tomorrow it could well see sterling begin to trade in a new, lower range.

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Home sales expected +0.8%, actual +8%!

Dallas Fed President Robert Kaplan was seemingly charged with providing the market with some crucial advance guidance yesterday. He told an interview with Reuters that he would prefer for tapering of the Central Bank’s support for the economy to begin before the end of the year.

It must be assumed given the way in which Regional Fed Presidents have acted recently that this was a deliberately planned move that marks the beginning of a shift for the Fed.

He cited several factors that are still creating a drag on the recovery but predicted that although inflation will become more broadly based, he expected it to have fallen to around 2.4% by Q2.

It is unclear whether he had any advance warning of tomorrow’s NFP data, but he went on to say that there are still supply constraints within the labour market.

Today will see the release of weekly jobless claims, with the recent falls to continue, although the rate of change is slowing. Yesterday’s private sector jobs data showed that 692k new jobs were created in that sector. That is down on last month but exceeded the market’s expectations.

Data for pending home sales was released and gave a significant indicator of the continued pent-up demand in the housing market.

Against a May fall of 4.4% and a market expectation of a 0.8% decline, pending sales rose by 8%.

This week’s data has led commentators into a view that the jobs market is beginning to show consistent, if not spectacular, progress.

This has been coming since the last NFP as depicted by the weekly claims data.

Kaplan’s comments had the expected effect on the dollar index. It rose to a high of 92.44 closing at 92.36.

Similarly, to both the pound and euro, the dollar index appears to be on the cusp of moving into a higher range. Yesterday’s high was its highest level in three months.

While there is a lot riding, short-term, on tomorrow’s NFP data, the longer-term trend will have far more to do with the guidance coming from the FOMC.

Central bank facing significant interference

The ECB is continuing to drive home it’s supposed independence from interference from individual states and highlighting the democratic value of its Governing Council being made up of the heads of the constituent Central Banks.

Christine Lagarde has been fairly clear in recent comments that the majority of the Council believe that keeping the level of support as it is, while possibly overkill, will ensure that the economy returns to its pre-Covid level sooner.

With the frugal five, headed by Germany, growing more concerned about inflation almost by the day, Lagarde faces a tough task to ensure that the majority decision-making process remains in place.

Data, released yesterday, shows that inflation is somewhat subdued. The first estimate shows that inflation was slightly lower last month. This is despite the continued reopening that sees pent-up demand steadily rising.

It is possible that Lagarde wants to make sure the economy is on a steady footing before the Bank begins to tackle the structural problems that will remain once the dust clears.

Jens Weidmann, the mouthpiece of the frugal five, commented earlier this week that he believes the Central bank should curb its bond purchasing programme before the end of Q1 ‘22.

That view won’t have been helped by the data, which showed inflation fell to 1.9% from 2% last month.

There are several anomalies created by the fact that data collection across such a vast area is inconsistent, but there can be little argument with a fall in inflation, no matter how small, when viewed through the lens of rising inflation being seen in other G7 economies.

The fall in inflation has also come at a time when the currency has begun what appears to be a long road lower. The 1.20 level versus the dollar appears to be receding in the rear-view mirror as support at 1.1700 appears on the horizon.

Yesterday, the single currency tested short term support at 1.1845 but managed to claw its way back to close at 1.1857.