Though this week's economic calendar features several notable events – including the FOMC meeting (Wednesday) and October employment report (Friday) – the eyes of the world will be focused on the US election where the majority of polls continue to show the Democratic challenger Biden leading Republican incumbent Trump by a healthy margin. That said, polls have narrowed in some key battleground states such as Florida, and memories of 2016 remain fresh for market participants.
A couple of fund manager surveys floating around the markets still have "contested election" right up there with "Covid-19" as the most significant market risks right now. The nervousness in asset markets going into Tuesday makes sense.
It's encouraging that trades like long CNH are not scared despite the pullbacks in mega-tech, gold and the USD, which suggests this week's market vagaries are little more than positioning events as the street didn't want to go into the election holding too much risk with Covid ravaging the EU and US, and not a change in the overall macro narrative to something more unhealthy.
A blue sweep, in which Biden wins the presidency and Democrats take control of the Senate, appears the most likely outcome according to polls and model projections. That result would provide the most fiscal stimulus to the economy in 2021. While the Biden plan does detail about $2.5tn of tax increases over the next decade, the markets suspect stimulus first and taxes later when the economy is on firmer footing, likely late 2021 or early 2022. That would provide a boost to global stocks, especially those "heavy" cyclical EU indices and "heavy" miner constituent bourses like the ASX on the reflationary impulse from infrastructure spending.
The Fed economists' models' simulations show that an additional $2tn stimulus package could significantly boost the economy next year, lifting real GDP growth by about five percentage points, adding 3 million jobs, lowering the unemployment rate by nearly two percentage points, and a robust S&P 500 performance in 2020 – although gains would likely slow significantly in 2021 as higher tax announcements would dent on forward earning (Federal Reserve Board).
After the latest Covid-induced pullback, prices should now be in a more balanced spot going into the big event. The runway is much cleaner for asset prices to take off and react more asymmetrically to the Democratic sweep scenario.
The key to unlocking a Democratic Congress and the associated expectations of significant fiscal stimulus is the Republicans losing the Senate.
One of the critical cross-asset signals will be a steepening of the US curve, where the 5s30s spread should shift much higher than the late October steepeners. This move ostensibly represents a reflationary dynamic, independent of the ebb and flow of the Covid news flows which have seriously dented the reflationary narrative in the lead-up to the election.
This outcome's asset-market impact will likely focus on the impact of more lavish fiscal spending, bullish for equities, and the bonds bear steeping will encourage USDJPY upside. The impact on EM assets, particularly commodity-driven equity markets and their related currencies, could be flattering on fiscal spending expectations.
By contrast, a Biden presidency and split Congress indicates a disinflationary outcome for markets on diminished fiscal policy expectations.
However, weighing down the reflationary impulse is the Eurozone, which is in the front line of concerns around end-demand that are leaning against global risk sentiment after France and Germany announced significantly tighter social distancing measures.
Eurozone restrictiveness has moved from a rating of 2.3 in late August to 6 this week (on a 0-10 scale). Two countries are back in 'extreme' territory (a score of more than 7): the Czech Republic (7½) and France (7). (source: UBS)
And now that all the big countries have significantly increased restrictions, this poses the most significant material downside risk to the global economic outlook.
There are two precise transmission mechanisms of tighter social mobility measures in the Eurozone that could hurt EM. First is that EM economies with significant regional financial and trade links with the Eurozone will underperform (PLN, HUF, CZK, etc.)
Second, beyond the domestically driven headwinds, lower oil prices (Brent front-month prices are 12% lower vs. last week's highs) reflect weaker demand prospects from the regions and economies with a significant oil export quotient (RUB, BRL, MXN) look set to struggle as OPEC producers are debating whether the output cuts due to expire in January should be extended.
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