Sell On Fact

It was a case of buy on rumour, sell on fact at the end of last week, with US equities falling the most in over a week on Friday in the wake of the much anticipated but largely priced in announcement of President-elect Biden’s $1.9 trillion fiscal plan.  While the amount of stimulus is significant the reality is that it will be difficult to pass through Congress even though Democrats will have control of Congress and the Presidency. Something in the region of $1 trillion fiscal stimulus could end up being the price tag that is eventually passed in Congress given Republican opposition to some of the measures in the stimulus plan.  This would likely be followed by a possible $2trn+ plan for infrastrucutre/green spending.

Note that a 60-vote supermajority will be required to pass the fiscal legislation in the Senate, meaning that several Republicans will need to support the bill given the 50/50 Senate split.  Hence, a likely lower than $1.9trn eventual stimulus bill will be what is eventually passed. However, Democrats can pass the spending bill via “reconciliation”, but they would have to remove unrelated measures such as the proposed increase in the minimum wage, which they will unlikely want to do. 

Treasuries and the US dollar (USD) benefited from a worsening in risk sentiment at the end of last week.  USD positioning is at extremely low level, suggesting scope for some short covering. The VIX equity volatility index ticked higher and continues to remain well above its pre-COVID lows.  Given that many key equity gauges were in overbought territory according to their relative strength index (RSIs) some pullback/consolidation could be on the cards though the glut of global liquidity suggests that there is still plenty of money ready to buy on dips.  Yesterday US markets were closed due to the Martin Luther King Holiday, but Canadian and European stocks ended higher and futures point to gains today. 

US data isn’t helping sentiment, with yet more evidence that the economy was under pressure at the end of 2020.  Retail sales fell for a third consecutive month, the New York Empire manufacturing index fell for a fourth consecutive month in January. Lastly, University of Michigan consumer sentiment fell modestly early January.  Market direction today will likely come from the release of China’s December data dump as well as Q4 GDP.  In contrast to weakening US data Chinese data yesterday highlighted that solid recovery was sustained into year end, with GDP beating expectations, rising by 6.5% y/y in Q4 2020.  

The rest of this week is a heavy one for central bank decisions, with China, Malaysia, Canada (Wed), Indonesia, Eurozone, Turkey, South Africa, Brazil (Thu) and Japan (Fri) on tap.  In terms of policy action Malaysia is likely to cut, Turkey will likely tighten but the rest will likely be on hold.   The main event of the week is Joe Biden’s inauguration as 46th President of the US on Wednesday, and attendant risks of renewed unrest.  US Q4 earnings releases will also be in focus in the days ahead, with earnings releases ramping up over coming days.

Markets Firm Despite Weak Data and Political Mayhem

Following an eventful (to put it mildly) week in US politics, the main thrust for markets is that the prospects of another sizeable US fiscal stimulus package has increased as Democrats will now take the Senate following the Georgia run-off elections as well as the House and Presidency.  The Blue sweep effectively gives Democrats more potential to pass policies without the constraints of requiring Republican support in the Senate.  That said, the Senate may not be willing to pass significantly more progressive measures given that the seats will be 50/50 for Republicans and Democrats, with the deciding vote coming from VP-elect Harris.

The data/markets dichotomy was once again clear from the weakness in the US December payrolls data on Friday, which revealed a 140,000 drop (consensus +50, 000) as Covid restrictions severely impacted leisure and hospitality jobs.  If anything, this will just add to pressure for more fiscal stimulus. US markets don’t care about soft data or are at least looking past it, with key indices reaching record highs last week led by tech stocks. Stocks and risk assets overall registered a stellar first trading week of the year amid a glut of liquidity even as US Treasury yields pushed higher.  

The US dollar also finally strengthened, gaining some respite amid a market positioned short and despite very negative sentiment.  More gains are likely if the USDs positive relationship with US yields continues to re-establish itself, assuming US Treasury 10 year yields push higher amid further bear steepening as expectations of more fiscal stimulus grow. The same cannot be said for gold prices, which tanked 4% at the end of last week as gold’s negative correlation with US Treasury yields took effect.  Asian currencies and local currency bonds will likely also face headwinds in the near term as the USD consolidates further. 

Aside from steps in the US House towards impeaching President Trump for a second time and any measures announced by the US administration in its final days, markets will focus on US (Wed) and Chinese inflation (tomorrow) data this week.  Both releases are unlikely to provoke any concern about inflation pressures even as market inflation expectations push higher.  Australia (Nov) and US retail sales data (Dec) (both tomorrow) will give some colour on how the consumer is faring.  In this respect US data will likely disappoint.  Other key data and events this week include China trade data (Thu) and rate decisions in Poland (Wed) and Korea (Fri). Chinese trade data is likely to reveal another strong reading for both exports and imports while Poland and Korea policy rates are likely to remain unchanged.

US Fiscal And UK/EU Brexit Discussions

The worse than expected US jobs report on Friday failed to stop the S&P 500 from registering another record high, but it does put even more pressure on US legislators to agree on a fiscal stimulus deal.  US November non-farm payrolls came in at 245,000, below the 460,000 consensus expectations and while the unemployment rate dropped to 6.7% from 6.9% previously this was all due a drop in the participation rate.  In other words the fact there are less people registering as actively looking for jobs has flattered the unemployment rate. Payrolls growth has slowed sharply and there are still 9.8 million more unemployed compared to February while further COVID restrictions point to more weakness in jobs ahead.  The good news is that some form of compromise is emerging on Capitol Hill, with a bipartisan proposal of $908 billion gaining traction, though frictions remain over aid to states and local governments and liability protections for businesses.

This week is crucial for Brexit transition deal discussions. The weekend phone call between UK PM Johnson and European Commission president von del Leyen made little progress on outstanding issues including fishing rights and level playing field.  Irish PM Martin noted that talks were on “a knife-edge”. European Union leaders are looking for a deal to be agreed upon before the European Council meeting on Thursday though time is running out.  The lack of progress is weighing on the pound (GBP), which took an initial dive this morning before recovering somewhat.  As it stands, the UK will leave the EU on December 31 with or without a deal.   Further complicating matters the UK’s Internal Market Bill, which gives ministers power to rewrite parts of the original Brexit divorce deal, will return to parliament today.

This week’s data and event slate is likely to kick off with upbeat Chinese November trade data; both exports and imports are likely to record healthy increases (Bloomberg consensus: exports 12.0% y/y, imports 7.3% y/y). The data is likely to bode well for risk sentiment, and for Chinese and Asian markets today.  Policy rates decisions in Canada and Europe will be of interest, especially with the European Central Bank (ECB) (Thu) likely to deliver a further easing.  Bank of Canada (Wed) is unlikely to reveal any major changes to policy.  Inflation data in China (Wed) and the US (Thu) are likely to reflect the disinflationary impact of COVID. Finally, the EU Leaders’ Summit may sign off on any Brexit agreement assuming there is one by then while an agreement on the EU Recovery Fund is unlikely to be reached.  

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.

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