Asia Macro Morning: Reflation trades gaining traction

Market Analysis / 3 Min Read
Stephen Innes / 06 Oct 2020

US equities and oil prices continue to pare last week's losses, while the UST curve is bear steepening. 

US President Trump has been discharged from the hospital following his Covid diagnosis the previous week. By reducing uncertainty around his ability to lead the Republican campaign to election day, the reaction has been positive for risk assets.
Growing expectations for US fiscal stimulus have been rising in parallel with the President's hospitalization, judging by the bear steepening in the UST curve.
 
The timing of fiscal stimulus becomes essential at some point. Still, for now, the increasing possibility of a Biden presidency (64% vs. 59% a week ago, according to PredictIt) and a Democrat-majority House (88% vs. 85%) and Senate (67% vs. 58%) should prove reflationary for financial assets that boost commodities (e.g. XAU, oil, copper) and high-beta risk currencies (e.g. AUD).

The primary risk to reflation trades is a boost for President Trump in the polls. It will take a few days before the impact of the President's illness filters into the election polls, and this matters because polling in the swing states suggested a much closer result than implied by prediction markets. I expect volatility to pick up, especially in oil prices, which I suspect will still play out as a key barometer for election risk.
 
However, President Trump is unlikely to turn volte-face and take the US down the much more restrictive path around tightening social mobility measures, as Johnson's UK government did. Instead, the President could take a leaf out of Bolsanaro's book by doubling down and further downplaying the pandemic. This approach is unlikely to pull in undecided voters.
 
I’m not a political scientist but, after more than two decades in the hot seat as a G-10 Chief Trader, I have mastered the art of statistical analysis. And given the improvement in gathering accurate polling data since the 2016 debacle, the polls' consistent run suggests the race is Biden’s to lose.
 
Fear and Chaos

Fear of election chaos is slowly dissipating as odds of a blue wave rising and the dreaded red dragoon drop. But when a market is prepared for chaos, expect a lack of market chaos. Extreme volatility is a product of surprises, not desired outcomes. Ironically, now that the red mirage and the Trump miracle has been priced out, the potential for market chaos has risen again.
 
Most everyone seems to agree that a blue wave would be bad for the USD and potentially bad for bonds, and that’s the way markets have been moving.

The market seems to have settled on the idea that a Biden win is bullish for stocks too, as the return of stability and the promise of MMT-style spending outweigh any concerns about future tax hikes. Trump win: Good for stocks. Biden win: Good for stocks, which should provide that clear road to nirvana, right?

Maybe. But there’s that small matter of term premium getting priced into the bond yield equation, which will upset the equity apple cart if the Fed stops monetizing all debt. Anytime the market starts to price in a regime shift, look for volatility to spike as policy uncertainty most certainly will come to the fore. 
 


Oil Markets 

I’m still not bought into the oil rally and I expect any fiscal bounce to be faded as, in the absence of a vaccine, the risk of Covid-19 case count risk in the northern hemisphere, at some point, is bound to be a rally capper. We can already see its temper in price action in Asia today on the back of a combination of fiscal uncertainty and rising Covid case counts worldwide. But the more significant the delay on a fiscal package, the more antsy market will get.
 
I still think oil plays the role of a Biden barometer where the ESG and the democrats’ left-wing greening agenda will act as a deadweight for oil prices in 2021; OPEC is already targeting a $50 average. Hence, as Brent moves to $45, given the volatility and when combined risk-reward of owning oil contracts above that level, the bullish will likely dissipate in the absence of a vaccine. So, not a lot of topside dollar to work with on that view. 
 
The bottom line for oil is relatively straightforward: it’s hard to imagine any scenario in the near-term where travel gets back to pre-pandemic levels. Even with a vaccine in the pipeline (which there are numerous), there are gnawing concerns that we’re not in "Pump! Pump! Pump!" oil patch nirvana anymore – or ever will be again. 

For more market insights, follow me on Twitter: @Steveinnes123 

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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