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.  

US Elections Take Yet More Twists & Turns

Amidst mixed messages from the White House about President’s Trump’s health and a growing circle of US administration officials and Senate Republicans infected with Covid-19, markets will kick of this week with many questions about the running of government, prospects for fresh fiscal stimulus and the nomination of the new Supreme Court Justice. President Trump pushed for stimulus in tweet while in hospital but obstacles in the Senate remain, including the fact that the Senate has adjourned until Oct 19, a factor that will also delay the Supreme Court confirmation process. 

In what was already an election fraught with various issues, President Trump’s Covid infection has added another layer of uncertainty.  The fact that several of his campaign aides have tested positive also complicates his ability to campaign to try to close the gap with ex- VP Biden.  There is also the question of whether the President will be well enough to take part in the second Presidential debate scheduled for October 15.  Markets initial sharp negative reaction to the news that Trump had contracted the virus, on Friday was tempered by the end of the session suggesting some calm.  However, every piece of news on Trump’s health will be closely scrutinized in the days ahead.  

The US dollar ended last week firm and this trend is likely to continue given the uncertainty about events in the weeks ahead, which despite the fact that much of this uncertainty is US led, will still likely lead to some safe haven dollar demand. 

A weaker than consensus US September jobs report didn’t help markets at the end of last week, with non-farm payrolls coming at 661k (consensus 859k) while a 0.5% drop in the unemployment rate was due a drop in the participation rate.  US non-farm payrolls are still down 10.7 million from the levels seen in February, highlighting the still significant pressure on the US labour market despite the job gains over recent months. 

Attention this week will focus on Federal Reserve Chair Powell’s speech on Tuesday and Fed FOMC minutes on Wednesday, which will be scrutinised for details on how the Fed will implement average inflation targeting.  Also on tap is the US Vice Presidential debate on Wed between Mike Pence and Senator Kamala Harris, which hopefully will not be a fractious as the debate between President Trump and ex-Vice President Biden.  

Monetary Policy rate decisions in Australia (consensus 0.25%) on Tuesday and in Poland (consensus 0.1%) on Wednesday as well as the Australian Federal budget on Tuesday will also garner attention this 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. 

Don’t Fight The Fed, Markets Are Teflon Coated

The rally in equity markets since their late March lows has been tremendous.  Despite an unrelenting chorus of doomsayers who like me have worried about the shape of recovery, markets have been impervious to bad news.  At the end of last week the May US employment report provided the latest catalyst to boost markets, after the release of data showing a shock 2.5 million increase in non-farm payrolls compared to consensus expectations of a 7.5 million decline.  The unemployment rate also surprisingly fell, to 13.3%, compared with 14.7% in April.  The data was taken as an indication that the US economy was resuming activity more quickly than expected.   As a result, the S&P 500 closed 2.6% higher on the day and almost 5% higher over the week. Another support factor for markets over the week was the European Central Bank’s expansion of its stimulus package, adding a more than expected EUR 600 billion to its asset purchase programme.

The lesson here is to not fight the Fed.  While many of us have been looking at fundamentals and surmising that fundamentals do not justify the rally in stocks, the reality is that this rally is not about fundamentals, well at least fundamentals in the traditional sense of the word.  The Fed and global central banks have been pumping in vast quantities of liquidity via quantitative easing, and this has led a massive increase in money supply in excess of economic growth.  This excess has had to find a home and equities have been such a home.  As of last week the S&P 500 recorded its biggest ever 50-day rally, up 37.7% and shows no sign of turning even as forward price/earnings ratios look increasingly stretched and economic activity appears likely to return only slowly, not withstanding the jump in May payrolls.

There are clearly plenty of risks on the horizon as mentioned in my previous blog posts, with a key one being the fraught relationship between the US and China.  However, for now markets don’t really care or at least are choosing not to care.  What started as a narrowly based risk rally has increasingly drawn in a wider base of investors who have increasingly been caught in what is commonly termed as FOMO or the fear of missing out.  This is dangerous to say the least, as it suggests that investors are only jumping on to avoid missing out on the rally rather than due to any fundamental rationale.  Nonetheless, the risk of not joining the rally is to miss out on even further potential gains.  The rally in risk assets has continued to hurt the dollar, which slid further over the last week, but is looking somewhat oversold based on some technical indicators.

Direction this week will come from the FOMC meeting on Wednesday although it seems unlikely that the Fed will announce anything new.  Markets will be particularly watchful for any indication on whether the Fed is moving towards enhancing its forward guidance.  In the Eurozone, the Eurogroup meeting will garner attention as Finance Ministers discuss the EU’s proposed Recovery Fund.  In Asia, China’s May trade released earlier today data will set the tone for the week.  The data revealed that China’s May exports fell less than expected, dropping 3.3% y/y USD terms, while imports dropped much more than expected, falling by 16.7% y/y.   Importantly, Chinese imports from the US declined further, highlighting the lack of progress towards the targets set out in the “Phase 1” trade deal.

%d bloggers like this: