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.

Growth/Risk Asset Rally Dichotomy To Continue

Happy New Year!  2020 ended with record highs for US stock markets, capping off a solid year for risk assets amid massive and ongoing central bank liquidity injections.  In contrast the dollar index (DXY) ended the year languishing around its lowest levels since April 2018.  The dichotomy between the sharp deterioration in global growth and risk asset performance has widened dramatically.  Given the acceleration in COVID-19 cases over recent weeks and consequent lockdowns, especially in the US and Europe, this divergence is likely to be sustained and even widen further over the next few months, at least until various vaccines finally manage to stem the damage.

Two of the biggest stumbling blocks for markets over recent weeks/months have been US fiscal stimulus and Brexit.  Both have now passed with last minute deals, setting the scene for a clearer path in the weeks ahead though political obstacles have not disappeared by any means, with the Georgia Senate run-off elections scheduled for Tuesday.  The outcome will be crucial for control of the US Senate with Democrats needing wins in both races to take over. However, the races are too close to call according to polls. Separately the US Congress will meet on Wednesday to declare the winner of the Presidential election. 

On the data and events front the week begins with an OPEC+ meeting tomorrow, with officials deliberating on whether to expand output by up to 500k barrels.  There are also a series of December Markit manufacturing purchasing managers indices (PMI) tomorrow including in various countries in Asia as well as the release of the Caixin manufacturing PMI in China.  US data will take centre stage with the release of the ISM manufacturing survey (Tuesday), Federal Reserve FOMC minutes (Wednesday) and non-farm payrolls (Friday).  Overall, markets are likely to begin the year much as the same way they left 2020, with risk appetite remaining firm. 

One interesting observation as we kick off 2021 is that so many investor and analysts’ views are aligned in the same direction (long Emerging markets, short USD, long value stocks, etc), and positioning is already looking stretched in various asset classes as a result.  While I would caution against catching a falling knife there is a clearly a risk of jumping on the same bandwagon as everybody else in a market that is increasingly positioned in one direction.  Overall, while the risk rally is likely to continue to have legs in the months ahead, investors should be on their toes in the weeks ahead given risks of a positioning squeeze in various asset classes.

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 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. 

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