A Stellar Month

November has turned into a stellar month for risk assets, with major equity benchmarks globally, especially those that are dominated by value/cyclical stocks, performing particularly well.  Investors have been willing to bypass the escalation in Covid infections in the US and Europe and instead focus on the upside potential presented by new vaccines and a new US administration, with a line up including former Federal Reserve Chair Yellen, that is likely to be more trade friendly.  Ultra-low rates and likely even more moves in a dovish direction from the Fed as well as plenty of central bank liquidity continue to support risk assets.  While challenges lie ahead (weakening growth, Covid intensification, lack of fiscal stimulus, withdrawal of Fed emergency measures) as well as technical barriers to further short-term gains, the medium-term outlook has become rosier.   

China’s economy has led the recovery and provided plenty of support to Asian markets, commodity prices and currencies. This week’s data and events kicks off with China’s official manufacturing purchasing managers index (PMI) (consensus. 51.5) (Mon) which is likely to remain in expansion, providing further support for China linked economies and assets.  However, the impact on oil will also depend on the OPEC+ meeting (Mon and Tue). Despite the sharp 30% rally in oil prices over the month further output increases are likely to be delayed as producers look to solidify gains. That said, a lot of good news appears to have been priced into the oil market already.  In contrast, the US dollar has been a casualty of the improvement in risk appetite and has shown little sign over reversing its losses. Subdued over recent days by year end selling, the USD may show more signs of life this week. 

The other key event this week is the Nov US jobs report (Fri) where a slowing pace of job gains is likely (consensus 500,000, last 638,000), with new COVID restrictions taking a toll on employment. US Nov ISM surveys are also likely to soften (Tue & Thu), albeit remaining firmly in expansion.  In Canada, the federal fiscal update (Mon), Q3 GDP (Tue) and jobs data (Fri) will be in focus.  Australia also releases its Q3 GDP report (Wed) while In Europe the flash Nov HICP inflation reading will garner attention but most attention will be on ongoing Brexit discussions, which seem to be stuck on remaining issues such as fishing rights. Central bank policy decisions in Australia (Tue), Poland (Wed) and India (Fri) are likely to prove uneventful, with no policy changes likely. 

A Sour Note

Markets ended last week on a sour note as a few underlying themes continue to afflict investor sentiment.  The latest concern was the decision by US Treasury Secretary Mnuchin to pull back the Fed’s Main Street Lending Program despite Fed objections. The timing is clearly not ideal given the worsening in the US economy likely in the next few weeks amid a spike in Covid-19 cases, and lack of fiscal stimulus.  That said, these facilities have hardly been used, due in part to stringent terms on many of these lending facilities.  Also pulling the funds back from the Fed could give Congress room to move towards a fiscal deal.  The decision may also not get in President-elect Biden’s way; if he needs the funds for the Fed to ramp up lending the Treasury can quickly extend funding without Congressional approval when he becomes President.  However, no new credit will be available in these programs during the interim period before he takes office, which could present risks to the economy.

Equity markets will continue to struggle in the near term amid a continued surge in Covid cases.  The latest data revealed that the US registered a one-day record of 192,000 cases.  More and more states are implementing stricter social distancing measures, but its worth noting that restrictions are less severe than in March-April.   There are also growing concerns that the upcoming Thanksgiving holiday will result in an even more rapid spread of the virus, with the US centre for Disease Control and Prevention recommending Americans not travel over this period.  The battle playing on investor sentiment between rising Covid cases and the arrival of several vaccines, is being won by Covid worries at present, a factor that will likely continue to restrain investor sentiment for equities and other risk assets over the short term at a time when major US equity indices are running up against strong technical resistance levels. 

This week attention will turn to the Federal Reserve FOMC minutes (Wednesday) for the 5th November meeting.  While there were no new actions at this meeting the minutes may shed light on the Fed’s options to change “parameters” of quantitative easing (QE) and how close the Fed is to lengthening the maturity of its asset purchases.  Separately October US Personal Income and Spending data (Wednesday) will likely show some softening as fiscal stimulus fades.  Elsewhere, Eurozone and UK service purchasing managers indices (PMIs) (Monday) will likely reveal continued weakness in contraction territory as lockdown restrictions bite into activity.  Brexit discussions will be under scrutiny, with speculation growing that we could see a deal early in the week.  On the monetary policy front, decisions in Sweden and Korea (both on Thursday) will focus on unconventional policy, with potential for the Riksbank in Sweden to extend its quantitative easing program and Bank of Korea likely to focus on its lending programs and liquidity measures, rather than cut its policy rate.  Finally, expect another strong increase in Chinese industrial profits for October (Friday).

In Asia, official worries about currency appreciation are becoming increasingly vocal.  As the region continues to outperform both on the Covid control and growth recovery front, foreign inflows are increasingly being attracted to Asia.  This is coming at a time when balance of payments positions are strengthening, with the net result of considerable upward pressure on Asian currencies at a time of broad downward USD pressure.  Central banks across the region are sounding the alarm; Bank of Korea highlighted that its “monitoring” the FX market amid Korean won appreciation while Bank of Thailand announced fresh measures to encourage domestic capital outflows, thus attempting to limit Thai baht appreciation.  In India the Reserve Bank appears to be continuing its large-scale USD buying.  In Taiwan the central bank is reportedly making it easier for investors to access life insurance policies denominated in foreign currencies. Such measures are likely to ramp up, but this will slow rather than stem further gains in Asian currencies in the weeks and months ahead in my view.

Fiscal Deadlock/China data

This week kicked off with a heavy China’s Sep data slate and Q3 GDP today.  The data releases were positive, revealing yet more signs of strengthening recovery. Industrial production, retail sales, jobs and property investment all beat expectations while Q3 GDP fell short. The data supports the view that China will be one of the only major economies to record positive growth this year. This bodes well for China’s markets and will likely also filter into improving prospects for the rest of Asia.

In contrast US recovery continues to be at risk, with fiscal stimulus discussions remaining deadlocked; a 75-minute conversation between House Speaker Pelosi and Treasury Secretary Mnuchin yielded no progress at the end of last week.  Pelosi has now given a 48-hour deadline to agree on stimulus while Senate majority leader McConnell has scheduled a Senate vote on a more targeted $500bn bill tomorrow. Talks are scheduled to continue today but there still seems to be little chance of a deal this side of elections. 

On the data front, US Sep retail sales data registered broad-based gains on Friday, with headline sales up 1.9% m/m (consensus 0.8%). In contrast, industrial production fell a sharp 0.6% m/m in Sep (consensus +0.5%).  Lastly, Michigan consumer sentiment rose in the preliminary Oct report to 81.2 from 80.4 in Sep (consensus 80.5).  The lack of a fiscal deal means that the prospects of a loss of momentum in the US economy has grown, something that will become more apparent in the weeks ahead. US data is limited this week and instead focus will remain on progress or lack thereof, on fiscal stimulus as well as the Presidential debate towards the end of the week. 

Another saga that is showing little progress is EU/UK Brexit transition talks.  The stakes have risen, with UK PM Johnson warning UK businesses to prepare for a hard exit while threatening to abandon talks completely.  On a more positive note UK officials are reportedly prepared to rewrite the contentious Internal Market Bill, which may appease the EU.  Credit ratings agencies are running out patience however, with Moody’s downgrading the UK ratings by one notch to Aa3. The pound seems to be taking all of this in it stride, clinging to the 1.30 level against the US dollar, suggesting that FX markets are not yet panicking about the prospects of a no deal transition.

Several emerging markets central banks are in focus this week including in China (Tue), Hungary (Tue), Turkey (Thu), and Russia (Fri).  Of these Turkey is expected to hike by 150 basis points, but the rest are likely to stand pat.  Most central banks are taking a wait and see approach, especially ahead of US elections. Reserve Bank of Australia meeting minutes tomorrow will garner attention too, with clues sought on a potential rate cut next month.  

Host Of Central Banks In Focus

Well, last week, tech stocks had their worst week since March, with stability far from returning.  While the jury is still out, most still view the pull back in tech stocks as a healthy correction following a prolonged period of gains, blaming increased options activity over recent months for the magnitude of the decline. The buy on dip mentality is likely to continue to prevail, though tech stocks have not yet show any sign of wanting to make a convincing pull back.   

Signs of nervousness are clear; equity volatility remains elevated, but many investors are still sitting on healthy gains over recent months.  Given the low cost of funding, low returns in government bonds, alongside continued strong demand for stay at home electronics and a vaccine that could still take months to arrive, it is hard to see the tech sector falling too far.   

The fall in the pound sterling has been quite dramatic over recent weeks, both against the US dollar and euro.  Fears over a collapse in trade talks with the European Union have intensified.  The sudden waking up of the market to these risks has been provoked by the prospects that the withdrawal agreement with the EU will be torn up, prompting threats of legal action by the EU.

Time is running out to get a deal on the table before the end of the Brexit transition period at the end of the year, but UK Prime Minister Johnson has said that the internal market bill is necessary to prevent “a foreign of international body from having the power to break up our country.” The new legislation is already facing a rebellion in parliament. Against this background its hard to see GBP rally, with the currency likely to be particularly volatile over the coming weeks.

Attention this week will turn to several central bank decisions, with monetary policy makers in Poland (Tue), US (Wed), Brazil (Wed), Japan (Thu), Indonesia (Thu), Taiwan (Thu), South Africa, (Thu), UK (Thu) and Russia (Fri) all scheduled to announce their decisions.  After months of policy easing globally, this week will look rather boring, with none of the above likely to ease further.   

The Fed FOMC meeting will likely capture most attention, but there is potential for disappointment if the Fed does not provide further details on its shift to average inflation targeting in its forward guidance, even as the accompanying statement and Chair Powell’s press conference are likely to sound dovish. The US dollar has continued to stabilize, aided by the drop in GBP, but a dovish Fed could limit further upside in the short term. 

Aside from central bank decisions attention will be on US election polls, which take on more importance as the election creeps closer.  US fiscal stimulus talks have hit a wall, with little chance of progress this week, while US pressure on China and Chinese companies is likely to continue to be unrelenting as elections approach.  On the political front the race to take over Japan’s prime minister following the resignation of Shinzo Abe will conclude this week (Wed).   

Will Stability Return?

After a very nervous end to last week, with US tech stocks leading the sell-off in US equity markets amid lofty valuations, heavy positioning and stretched technical indicators, markets will look for signs that stability will return in the days ahead.  However, the November US election is increasing in prominence as a market driver, something that is beginning to manifest itself in equity volatility and will likely play more of a role for FX and rates markets volatility going forward. 

The fact that there has been little progress between Democrats and the US administration on further fiscal stimulus adds to the uncertainty for markets ahead of US elections.  Also after Fed Chair Powell’s Jackson Hole speech in which he unveiled a new average inflation strategy, markets will look for this to be reflected in forward guidance. This could happen as early as this month’s FOMC meeting on September 16 but will more likely take place later.

After a torrid several weeks the US dollar made some recovery last week amid short covering, but underlying sentiment remains weak (latest CFTC IMM data shows speculative USD positioning languishing around multi-year lows).  Whether the USD can make a more sustainable recovery remains doubtful in the weeks ahead of US elections and is more difficult given the Fed’s more dovish shift.  However, in the near term there may be more scope for short covering.

Key highlights this week are China Aug trade data today, US Aug CPI (Fri), Bank of Canada meeting (Wed), European Central Bank (ECB) and Bank Negara Malaysia (Thu).  Among these the ECB meeting will be interesting; while a policy change is unlikely the ECB will probably highlight its readiness to act further to address downside inflation risks.  The ECB may also be more vocal about the recent strengthening of the euro to a two-year high, but aside from jawboning, there is little the ECB is likely to do about it. 

Emerging markets assets have benefitted from a weaker USD and but with growth remaining under pressure as likely to be revealed in weak Russian and South African GDP data this week while Covid cases in many EM countries continue to rise rapidly, risks remain high.  China’s trade data will give some early direction this week, but with US-China trade tensions only likely to escalate further, the outlook for emerging markets assets is clouded in uncertainty. 

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