Greater political certainty following the US presidential election is driving sharp declines in implied volatility. This dynamic is especially noticeable when viewed through the lenses of US equities and CNH, relative to their storied history, which pushed the S&P 500 to its best week since March and USDNCH to the lowest level since June 2018.
Asian equities are setting new highs for the year – the MSCI Asia Pacific Index rose 6.3% last week - but an extension of these trends that benefit risk appetite more broadly depends on the incoming US administration reining in the US coronavirus outbreak and driving bipartisan efforts to deliver some form of fiscal stimulus.
More limited fiscal stimulus than under the expected 'blue wave' election put more pressure on the Fed which cannot vaccinate the global economy from the negative economic fallout from the virus – but it can create a bridge to a post-vaccine environment.
Risk markets are pricing out more election uncertainty as downside hedges uniformly topple like dominoes across the board at the Monday open in Asia as local markets look to trade higher today after the Biden election victory was confirmed over the weekend.
Risk assets performed strongly last week across the board, coming up from a pre-US election low base. Many investors took chips off the table ahead of what was expected to be a long US Presidential election race.
But in bullish fashion, most managed to buy their way through the uncertainty by recognizing that a split Congress is still suitable for stock markets on the silver lining premise that the two parties will keep each other in check on issues like taxes and regulation.
The equity performance was in line with a rates market sell-off as investors rotated back into risk assets as the election result became clearer.
Ultimately, the bullish stock market view coalesces around several crucial narratives.
Lower interest rates (lower forever) support valuations and take compounders to the next level. The lower forever interest rate mantra – which has not only been the rallying cry for this enduring stock market bull cycle but even today amid lingering contested result uncertainly –unambiguously supports virtually everyone's investment books.
Last week, the reflation trade was rapidly priced out, but positive vaccine news was the ultimate downside rev limiter as the US dollar slide continues. However, Senate Majority Leader McConnell has sounded a tad more open to a stimulus deal. This shift in tone increases the chances for a lame-duck package and could hint at the potential for a somewhat larger stimulus deal than the street had initially thought. As such, the current baseline assumption of a roughly $750bn+ fiscal package legislated by Q1 has a reasonable chance to be exceeded.
Pricing out of global geopolitical risk under a Biden presidency could be the most undervalued plus of them all, as global supply chains could then redistribute goods in a more globalized fashion and could even return to the pre-pandemic status in the next 12- 24 months – if a vaccine proves to be the ultimate recession stopper and a game-changing panacea for global growth.
China exports resilient; Singles Day is up next
China's exports rose 11.4% y/y in October – its most assertive since Mar-19 (3.3% m/m, sa) –amidst a sustained global growth recovery and demand for C-19 related products. This export resilience amidst expectations of lower US-China trade uncertainty (post US elections) is a welcome tailwind for the RMB and a raft of growth assets.
I still like $CNH at 6.50 by the end of 2020. Still, the risk to the view is the recent increase in global growth uncertainty (i.e. lower US stimulus expectations and mobility restrictions in the EU) as a potential risk. But this could get offset by vaccine news into year-end.
Elsewhere, Singles Day sales stats could be a useful anecdote of rebounding consumption.
What can go wrong?
The Democratic party played this election like a fiddle, and regardless of what side of the floor you’re on, you can give them credit for that.
Due to the political stoking of fears of contracting Covid-19, a massive push was made, mostly by the left, to encourage voting by mail, and the bulk of the motivation came in huge electoral college states. Of course, this significantly altered the calculus as Democratic voters cast three times as many mail-in votes, and there’s absolutely nothing wrong with that.
Despite these media declarations, President Trump's campaign has still not conceded the race as it continued with legal challenges in various states. Media sources report those lawsuits' focus relates to absentee and mail-in voting procedures in closely fought states.
Oil was in the red all-day Friday. It seesawed a few times but was unable to break above Thursday’s settlement price, which is perhaps the worst signal of all. WTI closed down 4.25% with Brent down 3.65% to close the week up 3.77% and up 5.29%, respectively.
Oil is trading a bit higher this morning in line with broader risk assets and a slightly weaker dollar as Joe Biden was declared the President, while on the data front both US jobs numbers and China's resilient exports numbers released over the weekend paint a better picture for the global growth outlook than expected.
However, what matters for oil is the pandemic, not the election results. As is the case for all commodities, oil is priced on the spot markets so the struggle is to breach the current supply level before prices can even think about starting to rise in any meaningful way. As lockdowns in Europe accelerate and localized outbreaks in the US widen, oil markets will likely be further tested during what’s shaping up to be a winter of despair for oil prices.
More forward-looking anticipative assets like stocks, supported by low-interest rates, can look past the next several months of volatility and begin to price a recovery. Oil, however, does not have this luxury as it’s more tightly held captive to near-term supply, demand and inventory capacity.
USD weakness is painting a picture of more significant US political and economic uncertainty as safe-haven demand declines. Demand for fewer USDs is not especially surprising after the election event.
However, rallies in GBPUSD and AUDUSD are noteworthy after the BoE and RBA announced new rounds of easing last week, while the ECB has set up investors for further measures in December. For now, the marginal impact of QE via the currency channel in driving looser financial conditions is dissipating as the market turns focus to growth channels.
This election was much closer than anyone could have imagined, and partial rejection of identity politics and further left economics like MMT. While the Senate will probably not be resolved until January 5, 2021, it still looks about 85% likely to go red; that’s gridlock any way you want to spell it.
Anyone that had long USD or shorts SPX election hedges removed them. The market wants to be short USD regardless (long term running dual deficit thesis) but reduced into the election or stopped out on the two USD rallies beforehand.
With the risk event mostly in the rear-view window for FX, everyone rushes to get short again as value at risk algorithms reset; volatility plummets, real money sells USD. FOMO leads to global stock buying, triggering a mechanical USD selling via lower volatility and, of course, Asia continues to sell the dollars on Joe Biden, the Mr. Nice Guy to Asia trade.
The presumption for the dollar move is a narrative that’s mostly ex-post justification, and of course I’m still confused why the Euro is trading near 1.1900 with Covid ravaging the continent.
For more market insights, follow me on Twitter: @Steveinnes123
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