- Today’s Beige Book will show some economic recovery but Fed officials remain negative
- U.S. manufacturing production expected to recover but remain far below pre-pandemic level
- Trump administration moves toward Hong Kong sanctions
- China Q2 GDP expected to partially recover
Today’s Beige Book will show some economic recovery but Fed officials remain negative — Today’s Beige Book report will show some improvement in the U.S. economy after the debacle seen in March and April when nearly all non-essential businesses in the U.S. were shut down.
The Fed’s last Beige Book, released on May 27, said, “Economic activity declined in all Districts — falling sharply in most — reflecting disruptions associated with the COVID-19 pandemic.” The Beige Book noted weakness in nearly all sectors, including consumer spending, auto sales, residential home sales, manufacturing, construction, agriculture, and energy.
While the U.S. economy has rebounded higher from its trough, Fed officials continue to express pessimism about the medium-term prospects and are generally calling on Congress to provide more fiscal help. There is concern that the U.S. economy will take a turn for the worse as fiscal stimulus measures expire, such as the PPP payments and the $600 per week unemployment bonus at the end of July.
Dallas Fed President Kaplan on Tuesday said, “I’m worried that since mid-June, the rebound that we expected at the end of the second quarter and in the third quarter is stalling somewhat.” Meanwhile, Fed Governor Brainard on Tuesday said, “A thick fog of uncertainty still surrounds us, and downside risks predominate.” She added, “Fiscal support will remain vital.”
Today’s Beige Book is being released ahead of the FOMC meeting in two weeks on July 28-29. The market is unanimously expecting the FOMC at that meeting to leave its policy targets unchanged. The Fed is talking about possibly adopting a stronger form of forward guidance to reassure the markets that interest rates will not be rising, but the Fed is not likely to go so far as to implement a yield-curve control policy with interest rate caps.
Regarding those topics, St. Louis Fed President Bullard on Tuesday said he sees little need for stronger forward guidance or yield curve control because market “expectations are already low as for the outlook for interest rates.” As long as the markets are projecting low interest rates for the next several years, there is no need for the Fed to go out on a limb by adopting interest rate caps.
In fact, the markets currently believe that the odds are greater for a Fed interest rate cut than a hike through mid-2023. The federal funds futures curve has dipped as low as -0.05% for spring 2022. That means that the market is discounting about a 56% chance (14 bp/25 bp) of a Fed -25 bp rate cut by spring 2022 from the current effective funds rate of 0.09%.
If anything, the Fed may need to revive its warnings that it will not adopt negative interest rates. Fed officials have consistently said that they do not intend to adopt negative interest rates because they don’t believe negative rates have been effective in Europe or Japan. Also, negative interest rates are harmful to individual savers and bank profitability. Negative rates could also spark a run on U.S. money market funds, which could cause a new systemic financial crisis.
U.S. manufacturing production expected to recover but remain far below pre-pandemic level — The consensus is for today’s June manufacturing production report to show an increase of +5.7% m/m, adding to May’s recovery of +3.8% m/m. However, even if manufacturing production shows the expected increase today, the series would still have to rise by another +13.9% to return to February’s pre-pandemic level. That illustrates how big of a hole the U.S. manufacturing sector is still in.
Trump administration moves toward Hong Kong sanctions — President Trump on Tuesday afternoon announced that he signed the Hong Kong sanctions bill passed by Congress. That will allow the Trump administration to move forward with sanctioning Chinese officials responsible for enforcing Hong Kong’s new security law. U.S. officials under the new law will also be able to sanction banks that deal with sanctioned individuals, although those banks will have a year-long grace period to comply. President Trump Tuesday afternoon also announced that he signed an order to revoke Hong Kong’s special trade status.
Separately, China early Tuesday announced sanctions against Lockheed Martin for its sale of missile parts to Taiwan. However, the impact will be minimal since Lockheed Martin is not allowed to sell anything to China in the first place.
The markets continue to take U.S./Chinese tensions in stride since there hasn’t yet been a big hit to the Hong Kong banking system and since the sanctions/counter-sanctions have so far been measured. As long as the Hong Kong banking system and the Asian financial markets are not disrupted, the markets appear willing to gloss over the U.S./Chinese tensions.
By contrast, the markets could react very negatively if President Trump were to suddenly lose faith in the phase-one trade deal and renew his threat of a big new round of tariffs on Chinese goods. However, President Trump on Monday provided some reassurance to the markets by saying that the phase-one trade deal is intact and China is buying U.S. products.
China Q2 GDP expected to partially recover — The consensus is for today’s China Q2 GDP to improve to +2.2% y/y after Q1’s plunge of -6.8% y/y. The markets will carefully watch China’s recovery from the pandemic since China was hit first by the pandemic and is therefore somewhat of a leading indicator for the rest of the world.
