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.

Asia In Demand

Equity markets managed to shake off Covid concerns at the end of last week despite virus cases in the US reaching a record high and Europe battling a full-blown second wave; S&P 500 and Russell 2000 hit record highs.  Asian equities started the week building on this positive momentum.  Helping markets was the news that advisors to President-elect Joe Biden have said they oppose a nationwide US lockdown despite the sharp rise in virus cases.  This will help allay fears that the US economy will weaken sharply over the next few months amid severe lockdowns and before a vaccine can be distributed.

Vaccine enthusiasm will likely play against Covid escalation in the days and weeks ahead. In the near-term slim chances of a sizeable US fiscal stimulus taken together with a more rapid increase in global Covid infections highlight clear risks to risk assets, and this may be enough to put roadblocks in place at a time when various equity indices are reaching key technical levels.  Conversely, it is too early to write the US dollar off in the short term even if the medium-term trend is likely to be downwards. 

Asia remains favoured within emerging markets, as the virus has come under control across most of the region.  News of the signing of the Regional Comprehensive Economic Partnership (RCEP) trade deal by 15 countries in the region after 8 years of negotiations, but without the US and India, provides another boost to regional economic and market prospects.  The deal is less extensive than the Trans-Pacific Partnership (TPP) as it removes around 90% of tariffs rather than 100% under TPP.  Nonetheless, it is estimated that the deal could boost the global economy by close to $200bn by 2030.  Although the deal still has to be ratified by a number of countries it is a step closer to a unified trade block like the EU.   

Additionally, Chinese data today ought to be supportive for regional assets even amid the threat of further sanctions by President Trump’s administration in the weeks ahead. China’s October activity data including industrial production fixed assets investment, property investment and the jobless rate were on balance positive, showing that China’s economic recovery is gathering steam.  The data will likely provide further support to China’s markets including China’s currency, though it effectively seals the case for no further easing by China’s central bank, PBoC, while giving the rest of Asia more fuel to rally. 

Over the rest of the week emerging markets central banks will garner most attention, with a plethora of policy rate decisions on tap.  Hungary (Tue), Thailand (Wed), Philippines (Thu), South Africa (Thu), and China (Fri) are set to keep policy rates on hold while Indonesia (Thu) is likely to cut by 25bps and Turkey is expected to hike its policy rate by 475bp hike (Thu).   Turkey in particular will be a focus in this respect given the replacement of central bank governor and the more than 10% rally in the Turkish lira last week.

Rocky Road

Despite the rally in US stocks on Friday, led by the technology sector, US stocks have fallen for four straight weeks.  The jury is still out on whether equities and risk assets in general can rally in the face of a host of uncertainties in the weeks ahead including the potential for a contested US election, fading US economic momentum, lack of progress on “Phase 4” US fiscal stimulus and a resurgence in virus cases globally.  What is clear, is that the road ahead is a rocky one, reflected in the fact that equity volatility (VIX) remains elevated and G10 FX options implied volatility around the time of the US election has spiked. 

One of the main beneficiaries of this uncertainty has been the US dollar lately, much to the detriment of precious metals given their strong inverse correlation.  It wasn’t that long ago that most commentators were writing off the USDs prospects and it’s still not clear that its recovery can persist.  The USD has hit its highest level in 2 months but will likely struggle if equities can eke out further gains in the days ahead.  In contrast, gold is trading around its lowest levels in 2 months.  While these trends may persist in the very short term, technical indicators (eg Relative Strength Index) indicate approaching overbought USD and oversold gold levels. 

This week, the main focus will be on the first US Presidential debate on Tuesday and US September jobs report at the end of the week.  While the US jobs report will likely show a relatively strong (when compared to pre-covid levels) increase in hiring (consensus around 900k), the pace of hiring is likely to slow and employment is still likely to be at least 11 million lower compared to February.  The battle for the new US Supreme Court Justice adds another twist, with President Trump announcing the nomination of Amy Coney Barrett and the Senate moving ahead to vote on this nomination this side of the election.  This has changed the dynamics ahead of the election battle, energizing voters on both sides. 

In Asia, China’s September purchasing managers indices (PMIs) and monetary policy decisions in India and Philippines will garner most attention this week.  China’s economy is emerging from the Covid crisis in good shape, helped by resilient exports performance, with medical goods and electronics exports performing particularly well.  This is likely to be reflected in China’s PMIs this week, which are set to remain in expansion territory. Meanwhile US government pressure on Chinese technology companies continues to rise, with the US government reportedly sanctioning China’s biggest chipmaker, SMIC.  This may draw a retaliatory response from China, such as adding US companies to China’s “unreliable entities” list.  

India’s Reserve Bank of India (RBI) monetary policy decision is likely to result in an unchanged outcome on Thursday.  While growth has been hit badly due to Covid-19, inflation has also spiked to well above the RBI’s target, leaving the central bank in a difficult position on policy.  Ultimately the RBI will have to ease monetary policy further, but it is unlikely to do so at its meeting on Thursday.  India’s economy is fast heading for a double-digit plunge in growth this year and unfortunately virus cases remain at very high levels.  The rupee has been resilient, however, and is unlikely to weak much further in the short term, even as the economy softens. 

Tough Times for the US Dollar

The US dollar had an awful July, with the USD index dropping by around 5% over the month, its worst monthly performance in 10 years. A range of factors can be cited for USD weakness including an asset allocation shift to assets outside of the US, worsening news on US Covid cases over recent weeks, improved risk appetite, US election concerns, lower real yields and fiscal cliff worries, among other factors.  Gold has been a particularly strong beneficiary of the malaise in the USD and declining real yield yields.  The Fed’s pledge to keep on aggressively supporting the economy and likely strengthening of forward guidance in the months ahead suggest that any increase in US interest rates could be years off.

It is still difficult to see the recent weakness in the USD resulting in a deterioration in its dominant reserve currency status though the longer the factors noted above remain in place, the bigger the danger to longer term confidence in the USD. As a reminder of such risks Fitch ratings downgraded US AAA credit rating to a negative outlook.  I do not expect markets and the USD to be impacted by the move, but it does highlight a worsening in US fundamentals.  While other currencies are still a long away from displacing the USD dominance in FX reserves, financial flows, FX trading and trade, the longer term risks to the USD are clear.

That said, the USD caught a bid at the end of last week resulting in a sharp retreat in the euro (EUR) from heavily overbought technical levels.  It is unlikely to be a coincide that this occurred as US Covid cases showed signs of peaking while cases in many parts of Europe began to accelerate, resulting in delays to opening up or renewed tightening of social distancing measures there.  US stocks have also continued to perform well, despite much discussion of a rotation to value stocks.  Solid earnings from US tech heavyweights solidified their position as leaders of the pack.  It is too early to say that this is the beginning of a USD turnaround, but the currency is heavily oversold in terms of positioning and technicals, which point to room for some respite.

Turning to the week ahead attention will be on July global Purchasing Managers Indices (PMI) data beginning with China’s private sector Caixin PMI (consensus 51.1), and the US ISM survey (consensus 53.6) tomorrow.  Central bank decisions include the Reserve Bank of Australia (Tue), Bank of England (Thu), Reserve Bank of India (Thu) and Bank of Thailand (Wed).  No change is likely from the RBA, BoE and BoT, but expect a 25bp cut from RBI.  At the end of the week two pieces of data will take precedence; US July jobs data and China July trade data.  US-China tensions will come under further scrutiny after President Trump vowed to ban TikTok in the US while pouring cold water on a sale to a third party.

 

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