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. 

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. 

Market Volatility Continues To Compress

The US Independence Day holiday kept trading, market activity and volatility subdued for much of last week.  In any case equity markets and risk assets have been struggling on the topside and appear to be losing momentum.  Markets are being buffeted by conflicting forces; economic news has beaten expectations. For example, the US June jobs report was better than expected though total job gains of 7.5 million in recent months are still only around a third of total jobs lost.  In contrast, worsening news on Covid 19 infections, with the WHO reporting a one day record high in global infections, threatens to put a dampener on sentiment.  Consolidation is likely, with Summer trading conditions increasingly creeping in over the weeks ahead. As such volatility is likely to continue to be suppressed, aided by central banks’ liquidity injections.

Over recent weeks geopolitical risks have admittedly not had a major impact on markets but this doesn’t mean that this will remain the case given the plethora of growing risks.  China’s installation of new security legislation into Hong Kong’s basic law and the first arrests utilizing this law were in focus last week.  A US administration official has reportedly said that the president is considering two or three actions against China, and markets will be on the lookout for any such actions this week, which could include further sanctions against individuals are more details of what the removal of HK’s special trading status will entail.  Meanwhile the US has sent two aircraft carriers to the South China Sea reportedly to send a message against China’s military build up in the area, with China’s PLA conducting a five-day drill around the disputed Paracel Islands archipelago.

Data releases and events this week are unlikely to lead to a change in this dynamic.  At the beginning of the week attention will focus on further discussions between the UK and EU over the post Brexit landscape while in the US the June non-manufacturing ISM survey will garner attention.  So far talks on a trade deal between the UK and EU have stalled though there were hints of progress last week, even as officials admitted that “serious divergencies remain”.  The US ISM non-manufacturing survey is likely to move back to expansion (above 50) but is increasingly being threatened by the increase in Covid infections, which could yet again dampen service sector activity. On the policy front there will be fiscal updates from the UK and Canada on Wednesday against the backdrop of ramped up spending, and monetary policy decisions by the Reserve Bank of Australia (RBA) and BNM in Malaysia on Tuesday.  The RBA is widely expected to keep policy unchanged while BNM may cut rates by 25 basis points.

 

Waiting For US Jobs Data

Ahead of the US jobs report later today and following a lack of leads from US markets after the 4th July Independence Day holiday, markets are likely to tread water, at least until the employment report is released.  However, there are plenty of factors lurking in the background including the ongoing US-China trade war, US-Iran geopolitical tensions, and growing trade spat between Korea and Japan.

Markets continue to be supported by expectations of monetary easing globally.  This week, bond markets have continued to rally, helped by President Trump’s nomination of July Shelton and Christopher Waller for the Board of Governors of the Federal Reserve, both of which are considered dovish.  Separately, markets applauded the backing of Christine Lagarde to lead the European Central Bank after weeks of wrangling by European leaders.

Immediate attention will be on the US June jobs data.  Market expectations are for a 160,000 increase in non-farm payrolls, unemployment rate at 3.6% and average earnings growth of 0.3% compared to the previous month, 3.2% compared to the year earlier.  Anything much worse, for example an outcome below 100k would likely lead to an intensification of expectations that the Fed FOMC will cut by as much as 50 basis points later this month.  An outcome around consensus would likely result in a 25bp easing by the Fed FOMC.

Separately trade tensions between Japan and Korea have intensified. Japan is implementing restrictions on exports to Korea of chemicals essential for chip making. Japan is Korea’s fourth largest export market. The new approval process required by Japanese exporters of three semiconductor industry chemicals will hit Korea’s tech industry at a time when it is already suffering.  The trade spat could also have widespread implications given the wide range of products that South Korean chips are used in, impacting supply chains globally.

USD weaker except versus JPY, EUR gains unsustainable

Risk aversion is creeping higher whether due to weaker data and budget concerns in the US, political uncertainty in Europe or tensions in the Korean peninsular. Central banks continue however, to do their utmost to keep monetary conditions sufficiently easy to facilitate recovery.

The Bank of Japan was the latest to do its part under the helm of governor Kuroda, with new measures including a major increase in asset purchases, delivering a positive surprise to markets while pushing the JPY sharply weaker.

Only the ECB appears to lag in terms of central bank activism keeping policy on hold last week despite weak economic conditions are ongoing austerity pain. A series of industrial production releases across the Eurozone including German February IP scheduled for release today will not change the picture materially.

The much weaker than expected US March jobs report in which payrolls increased by only 88k, concern that economic activity is following a similar pattern to previous years ie strength in Q1 followed by weakness in Q2, has intensified. I do not believe this is the case but the jury is still out.

At the least the data will embolden Fed doves who will use the data as evidence that any tapering off in asset purchases should not occur quickly. A series of Fed speeches this week including one by Fed Chairman Bernanke tonight will be listened to very closely to determine whether the jobs report has provoked further caution from the Fed. Moreover, Fed FOMC minutes will be scrutinized to determine how the Fed will adjust the flow rate of asset purchases to the changing outlook.

The overall tone to FX markets is one of broad based USD weakness, with the notably exception of the JPY where the relatively aggressive BoJ stance has provoked a bigger reaction. The EUR has taken advantage of a softer USD but is unlikely to sustain gains around the EUR/USD 1.3000 level given the political problems across the Eurozone and relatively weaker economic conditions.

Indeed, news that Portugal’s constitutional court rejected austerity measures has put at risk the ability of the country to achieve its budget targets and regain access to international bond markets. Meanwhile Cyrpus’ bail in continues to leave a sour taste among depositors across the region while Italy continues to edge towards fresh elections.

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