US equities were weaker Wednesday, the S&P down 0.2% after see-sawing between gains and losses all day. While talks continue on US stimulus measures, there were no breakthroughs overnight. GBP strengthened across the board after EU negotiator Barnier indicated a deal was within reach, while the UK mentioned it was prepared to begin "intensive talks." US 10Y yields lifted 4bps to 0.82% – the highest since early June as bond markets start to price in the eventuality of more stimulus, hence more issuances hitting the markets.
With investors suffering a severe case of stimulus talk exhaustion, more and more market participants are opting for the sidelines to avoid the steamrollers known to pancake markets in low volume conditions.
It’s always an exhausting pretense to maintain a long-term view when so much is getting wrapped up on a short-term stimulus fling.
Despite an optimistic tone and purported narrowing of differences, the pre-election fiscal stimulus's odds continue to look very low. Ongoing talks could make for some interesting debate during the lame-duck session of Congress in November and December, but the election outcome is likely to be the more important factor at that point.
And while negotiations are likely to continue into next week, given neither side wins from ending them. With the Senate unwavering in the thorniest issues of financial aid to states and liability protections, even a deal on compassionate grounds is starting to look unlikely as the Republicans in the Senate turn focus to backroom politics as Washington Post reports that Senate majority leader Mitch McConnell is concerned that any deal they reach could disrupt the Senate's plans to confirm Amy Coney Barrett to the Supreme Court next week.
US equities are trading in relatively tight ranges in the month-to-date; the ebb and flow of the stimulus debate around a near-term package appears to matter less to investors as what’s essential for market concerns is what different election outcomes mean for stimulus prospects in 2021.
And while the consensus might be that, with Biden leading in the polls, the odds of blue sweep increase, positioning is not there yet; speculative trading is not large because the event risk around the election is still significant. The mind games are setting in as the perceptions are still blurred by 2016 when polls were wrong on Brexit and Trump. Worrying about inaccurate polls feels like it’s the market’s final mind war, then again US election polls have only been wrong twice sine 1952.
The Blue Wave result has clear implications for a lower USD, and most believe it to be bullish stocks (spending outweighs tax cuts). The market has bet on this outcome a bit but wants to bet much more. Out of all the various possible election outcomes, this is the only crystal-clear outcome for how asset markets respond.
Oil prices pancaked overnight as traders were quick to sidestep the Hurricane Delta distorted data after inventories fell. But the most devastating read for oil prices was that gasoline consumption is weakening, which then fuses with the sum of all fears that Covid-19 is again starting to negatively impact consumer behavior at the pump.
The four-week average implied demand stood at 18.4mbd – down 2.7mbd (13%). Implied demand for gasoline and distillate is weakened, with gasoline consumption at 8.6mbd – down 0.8mbd (9%) y/y.
US politics continues to dominate trader focus as we await potential news on a new round of US stimulus while keeping an eye on the latest polls on the election. House Speaker Nancy Pelosi and Treasury Secretary Steven Mnuchin have reportedly moved "closer to an agreement," according to Pelosi's Chief of Staff on Twitter. Still, there’s much uncertainty over whether Republicans in the Senate will endorse any deal.
With just eight trading days between now and November 3, the hunt for Blue Wave USD shorts continues. While a stimulus deal may still theoretically be on the table, the election results could mean a considerably different outlook from the incoming administration; the latest average of polls gives Joe Biden about a 10.3ppt lead over President Trump.
Currency markets have minimal pre-election positioning and are now melding with the positive Biden election impulse. The probability of a Democratic sweep increases significantly, reducing post-election uncertainty.
The Chinese Yuan
The RMB is still going strong. Under China's "clean-floating" regime, the interest rate differential has turned into a massive driver of inflows. The historical relationship between the 2-year yield spread between CGBs and USTs and USD-RMB suggests the current exchange level is very close to equilibrium, which shouldn’t bother the PBoC.
But if the speculative forth kicks into overdrive and the CFETS RMB index rises further to make a new YTD high (i.e. above 96), effectively tightening monetary conditions and negatively impacting the economic recovery, to tame the CNH beast the PBoC could pull reigns by removing the fixing model's counter-cyclical factor – among several other non-aggressive intervention tools they have at hand, like injecting more liquidity via OMOs into the system.
So, the market now waits to hear from the PBoC.
The Malaysian ringgit
The stronger yuan, a Biden stimulus impulse and a weaker USD dollar will help assuage the ringgit's concerns over the negative read on oil prices and work from home orders to some residents in KL due to rising Covid-19 infections. But Asia currency markets seem to be running with Blue Wave stimulus hopes.
The British Pound
GBP firmed as a key EU negotiator says a deal is within reach.
The EU's chief negotiator said that a deal could still be achieved, despite the talks' suspension last week. For all the optimism around the restarting of Brexit talks, which has taken cable through 1.31, it’s not apparent any deal would prevent immediate damage to the UK economy.
Still, financial markets have reacted strongly to indications that negotiations are set to restart on Thursday to reach a deal by mid-November. The fact that long positioning was much cleaner is likely getting reflected by the fact the street was tripping over itself to get topside positions as offers were far and few between.
Restarting negotiations does not mean a deal –it doesn’t even suggest a 'tunnel.' It’s become clear over the last week or so that the UK is unwilling to walk away from the talks, and neither is the EU. While there’s still a possibility the negotiations will go sideways, the probability of a limited, skinny trade deal has significantly increased.
The Euro (featured currency)
Was there more than meets the eye to the EU social bond story?
This week the European Union issued its first series of bonds connected to the meaningful, and historically significant, Recovery Fund agreement which saw a massive reduction in the Euro's existential risk premium or increase in European unity, to trigger a 700-pip rally in Euro. The Sentix Euro Break-up Index remains at a shallow all time low levels – just like it was after Macron won in 2017. The October reading shows only a 5.2% chance of any Euro zone country leaving the single currency over in the next 12 months. That number got above 40% as recently as 2015.
And while we’ve talked a lot about the enormous order book influence effect the bond had on the EURUSD momentum, what’s now starting to resonate on the street is that significant demand also came from reserve managers; nearly 40% of the ten-year issue was taken up by central banks, close to double the average uptake in prior European issuance. Unlike many bond funds, central banks do not hedge the bond's currency risk component, which provided the direct throughput boost to the Euro. But, more significantly, this signals a vote of confidence to the EUR as a reserve asset, particularly when the US dollar's exorbitant privilege is being questioned.
Gold is perking up again as the US dollar trades a bit weaker across the G10 space and the eventuality of a stimulus deal coming to fruition is also boosting the fortune of the yellow metal.
My "Blue Wave" Currency Playbook
With just eight trading days between now and November 3, the hunt for Blue Wave USD shorts continues. Below is my pecking order – on a 10-star rating basis – for a Biden sweep, which remains well underpriced.
Gold (8 stars)
Gold will be the massive beneficiary for the next wave of US infrastructure spending. The Biden administration will paint America green while printing giant IOUs to found ambitious ESG projects, especially around green solar. A couple of bumps on the road to blue wave Nirvana could be an explosion higher in US yields and the insane amount of volatility the market has experienced. Still, I rate this trade 8 out of 10.
The Canadian Dollar (7 stars)
The Loonie is typically a direct beneficiary of more robust US growth, and Biden's massive infrastructure splurge will flow into Canada via commodities, construction and other building services. The road to Blue Wave nirvana is tempered because the Canadian dollar is but an asset bubble sitting atop the Athabasca oil sands, where oil is quickly becoming an unwanted investment asset.
The Chinese Yuan (6 stars)
I eventually see the RMB complex as the flagbearer for G-10 currencies in 2021. Right now, the yuan is the biggest reflation story in the market and should benefit from a Biden Presidency since the street believes it could ease US-Sino tensions. The roadblock to Blue Wave nirvana is that the trade is crowded, and the PBoC’s not-so-invisible hand will continue to push against the favorable yuan wind, albeit mildly.
Note that we’re only talking about the blue wave impact on this trade – not necessarily my longer-term views or the PBoC’s ambitions for the yuan.
The Japanese Yen (5 stars)
I like the catch-up trade to the yuan, where the RMB gravitational forces pull the JPY on a stronger tangent, But the most significant risk to this trade on Blue Wave nirvana is the stimulus torrent pushing US yields to the moon.
The Euro (2 stars)
The Euro is generally at the center of all major US dollar sell-off. Still, the road to Blue Wave nirvana (Euro higher) has several bumps along the way, including EU deflationary impulses, the ECB (which does not want the Euro to move higher), and Italy has stopped raising rates.
The Australian Dollar (2 stars)
With commodities expected to rip higher and the yuan surging, it should make sense to back up the truck on the Aussie, but the road to Blue Wave nirvana is blocked by the RBA which is about to ramp up QE.
For more market insights, follow me on Twitter: @Steveinnes123
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