Busy Week Ahead For Central Banks

US equities came under more pressure at the end of last week, with the S&P 500 falling to its lowest in four weeks, down around 2% month to data.  The drop will test the buy on dips mentality as the S&P is once again resting just above its pivotal 55-day moving average, a level that has seen strong buying interest in the past. 

Economic data gave little help to market sentiment, with the University of Michigan confidence index improving a little to 71.0 in early September but falling slightly below consensus expectations at 72.0.  Separately, the inflation expectations measures were broadly unchanged, with the most relevant series for Fed officials (the 5-10y) remaining steady at 2.9%, which is still consistent with the Fed’s 2% goal.

This week is all about central bank meetings, with an array of policy meetings including in Indonesia (Tue), Sweden (Tue), Hungary (Tue), China (Wed), Japan (Wed), US (Wed), Brazil (Thu), Philippines (Thu), UK (Thu), Norway (Thu), Switzerland (Thu), South Africa (Thu), and Taiwan (Fri), all on tap. 

Most focus will obviously be on the Federal Reserve FOMC meeting, during which officials will likely signal that they are almost ready to taper. A formal announcement is likely in December or possibly November.  Most other central banks are likely to stay on hold except a likely 25bp hike in Norway, 25bp in Hungary, and 100bp in Brazil.

Politics will also be in focus, with Canada’s Federal election and the results of Russia’s parliamentary elections today.  Polls suggest the incumbent Liberals ahead though the most likely outcome is a minority government in Canada while in Russia the ruling pro Kremlin United Russia party is likely to renew its supermajority. 

Other issues in focus this week are frictions over the US debt ceiling, with the House voting soon on raising the ceiling.  US Treasury Secretary Yellen renewed her calls for Congress to raise of suspend the debt ceiling stating in a Wall Street Journal op-ed that failing to do so “would produce widespread economic catastrophe”. 

In China, Evergrande’s travails will be in the spotlight on Thursday when interest payments on two of its notes come due amid growing default risks.  Indeed, China related stocks slid on Monday morning as Evergrande concerns spread through the market.  Property developer stocks are under most pressure and whether there is wider contagion will depend on events on Thursday.

The US dollar has continued to strengthen, edging towards its 20 Aug high around 92.729 (DXY) and looks likely to remain firm heading into the Fed FOMC meeting especially as it will hard for Fed Chair Powell to sound too dovish and given risks of a hawkish shift in the dot plot.  Positioning data is showing increasingly positive sentiment towards the dollar, with speculative positioning (CFTC IMM net non-commercial futures) data showing the highest net long DXY position since May 2020. 

Conversely, speculative positioning in Australian dollar has hit a record low likely undermined by weaker iron ore prices.  Similarly, positioning in Canadian dollar is at its lowest since Dec 2020 while Swiss franc positioning is at its lowest since Dec 2019. Asian currencies have been hit, with the ADXY sliding over recent days.  The Chinese currency, CNY has been undermined by weaker data and concerns over Evergrande while high virus cases in some countries are hurting the likes of Thai baht. 

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.

Finally, Back To The Economy

The election of President Elect Biden marks a new dawn for the US and the world.  The world had held its breath since Tuesday’s US election, wondering whether there would be four more years of the same or change.  A new Democratic President elect together with a split Congress, is arguably one of the best outcomes that markets could have hoped for, notwithstanding the fact that President Trump refuses to accept defeat. 

While the Senate is still up for grabs it seems more likely than not to stay in Republican hands; the Georgia run offs on 5 January could result in 50-50 in the Senate and effective Democrat control via Vice President elect Harris, but the probability of this is small.  As such, there seems little prospect that a Republican led Senate -– will be pliable to President elect Biden’s biding. 

Why is this good for markets?  It means that policies and members of Biden’s cabinet will likely veer towards more centrist as opposed to leftish aims.  It will for example, be difficult for Biden to hike taxes, which will take out some of the sting from a likely smaller fiscal package than Democrats had hoped for. And limited fiscal spending may keep the onus on the Fed to provide liquidity, underpinning markets further.  

Now that the Presidency has been decided, attention will turn at least in part, back to Covid and the economy.  Neither look encouraging.  Covid cases in the US have reached record levels.  US October jobs data released at the end of last week revealed an above consensus 638,000 increase in non- farm payrolls though the level of payrolls is still down a sizable 10.1mn from the level in February and the fading CARES Act spending alongside surge in Covid cases indicates risks to any further improvement going forward.

Top tier data is limited this week in the US, with inflation (CPI) as the main release on tap (Thurday).  Nonetheless, risk assets/equities are likely to continue to take on a positive tone in the wake of the election outcome. The USD is likely to remain under pressure as risk assets rally. 

A Biden presidency, split Congress bodes well for Asia.  The US stance on China would likely be more nuanced and US stance on trade would likely be more supportive.  As revealed in China’s October trade data over the weekend, exports are holding up particularly well even ahead of a Biden presidency; exports rose by a very healthy 11.4% y/y in October.  

The USD is likely to depreciate in the months ahead in the wake of a Biden win/split Congress, while US rates are likely to remain suppressed, which all point to Asian FX strength.  Fundamentals also point positively for Asia. Much of the region is recovering well from Covid related weakness, led by China, which now appears to be firing on all cylinders.

US Elections – The Proof Is In The Pudding

The week ahead is a huge for data and events.  First and foremost is the US Presidential election on Tuesday.  Polls show Democratic contender Biden well in the lead over President Trump, with around an 8.8% gap in polling between the two contenders.  However, Biden has lost some ground over recent weeks in polls including in key toss-up races though betting odds actually show a late shift back in favour of Biden.  Polls predict that Democrats will also take the Senate from the Republicans and add to their majority in the House. 

While the polls indicate a Blue Wave for the Democrats there is still a healthy degree of cynicism given how badly they predicted the outcome of the 2016 election, when most pollsters predicted a Hillary Clinton victory.  In recognition pollsters say they have changed their methodologies to correct for past errors.  The proof is in the pudding and until elections are over, investors will be holding their breath.  Even after election day itself, it is not clear that we will see an outcome quickly.  A jump in early voting may complicate things as well as the large amount of mail in voting, which could in some states take days to count. 

The problem may be more acute if the election is a close call, which polls are admittedly not suggesting, but nonetheless, the potential for multiple legal challenges and even civil unrest should not be discounted.  Note that States technically have until December 14 to certify election results.  Some states that will be key to either side will be Florida and Pennsylvania as well as Michigan,  North Carolina, Arizona and Wisconsin.  Florida in particular, could be essential, and could be one of the first states to be called on election night.  The winner in Florida has gone on to the win the Presidency in 13 of the 14 last elections. It is also one of the closest races this time around.

All of this is taking place at a time when Covid-19 cases are accelerating, potential a bad omen for Trump given that polls have shown widespread disapproval over his handling of the virus.  Indeed, Covid inflections in the US increased by 97,000 on Friday, the largest one day increase since the outbreak of the virus. The jump in cases were led by Midwestern states, some of which are major battleground states in the elections.  Admittedly, some of the increase in cases can be ascribed to higher testing rates, but hospitalisations have also risen sharply. 

All of this doesn’t bode well for the economy.  While the third quarter registered an above consensus increase in US GDP of 33.1% on annualised basis, the outlook for Q4 looks much softer and without a new fiscal stimulus package, momentum will slow sharply.  The labour market in particular is weak and while this week’s US October employment report will likely show a strong increase in non-farm payrolls (consensus 610,000), there will still likely be around 10 million fewer jobs since February.  The Federal Reserve FOMC meeting this week is unlikely to deliver any further support, with the onus squarely on more fiscal stimulus.

Equity markets have clearly become increasingly nervous heading into the election, with US stocks registering their worst week since March amid election nervousness and spike in Covid infections.   Tech stocks were hit despite mostly beating earnings expectations.  The US dollar in contrast, made some headway, but didn’t really fully capitalise on the sell off in stocks and rise in risk aversion, that would usually be expected to propel the currency higher.   If polls are correct and there is a strong outcome for Democrats in the election, stocks will likely find their feet again, while the US dollar will resume weakness. 

US Dollar Sliding, Gold At Record Highs

Risk sentiment has turned south and the US stock rotation out of tech into value has gathered pace, with the Nasdaq ending down for a second straight week.  Gold is turning into a star performer, registering a record high today, while the US dollar continues to lose ground.  Economic activity is slowing, second round virus cases are accelerating in places that had previously flattened the curve, while US- China tensions are heating up.  Attention this week will centre on US fiscal discussions while US-China tensions remain a key focal point.

Reports suggest that Senate Republicans and the US administration have agreed on a $1 trillion coronavirus relief package.  This will be the opening offer in discussions with Democrats (who had passed a $3 trillion package in House in May), with less than a week before unemployment benefits expire.  Whether the $1 trillion on the table will be sufficient to satisfy Democrats is debatable and a figure of around $1.5 trillion looks plausible. Time is running out and pressure to reach a compromise is growing.   Further uncertainty will likely weigh on US markets in the days ahead.

US-China tensions remain a key focus for markets. Worries about a dismantling of the Phase 1 trade deal still looks premature even as China has fallen behind in terms of purchasing US imports.  The closure of the US consulate in Chengdu following the closure of the Chinese consulate in Houston will be seen as a proportionate move, that is unlikely to escalate matters.  Nonetheless, a further escalation is inevitable ahead of US elections in November, with a broad array of US administration officials becoming more aggressive in their rhetoric against China.  As such, further sanctions against Chinese individuals and companies could be on the cards.

The week could prove critical for the US dollar given that it is breaching key technical levels against a host of currencies, with the currency failing to benefit from rising risk aversion recently. While not a game changer the European Union “recovery fund” is perceived as a key step forward for the EU, a factor underpinning the euro.  Key data and events over the week include the Federal Reserve FOMC meeting (Wed), US (Thu) and Eurozone Q2 GDP (Fri) and China purchasing managers indices (PMI) (Fri).  US Q2 earnings remain in focus too.  Before these data releases, today attention turns to the German IFO survey (consensus 89.3) and US durable goods orders (consensus 6.8%).

 

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