Asia Open: US fiscal stimulus gets put on ice

Market Analysis / 7 Min Read
Stephen Innes / 07 Oct 2020

Recap 

US equities were weaker Tuesday, the S&P down around 1.4% heading into the close. Equities turned sharply weaker after the US President indicated that negotiations on further fiscal stimulus measures had been put on ice until after the US election. That announcement couldn’t have come at a worse time from the market's perspective, given it came just a few hours after Fed Chair Powell warned of "tragic" risks for the economy if further fiscal stimulus is not forthcoming. Powell noted the "expansion is still far from complete" and that too little support would lead to unnecessary hardship.

Markets

President Trump putting a halt to stimulus talks was effectively pin pricking the stimulus balloon. And with no sweet fiscal honey to help float the market, the laws of gravity took over and global stock markets fell back to earth as traders turned focus to the latest warning from Federal Reserve Chair Jerome Powell that, without more funding, the economy is in deep trouble. 

It’s hard to argue that point, with the steady stream of bad news in the last week about job losses as more and more companies put the finishing touches on restructuring plans that involve significant retrenchments.

The absence of a fiscal float might now also cause some concern that a Democrat clean sweep could bring higher taxes and sterner regulation, offsetting some of the enthusiasm from higher budgetary spending. 

Risky business in risky times

However, the stimulus is coming –it now just gets a little tricky. If the market is right about a Democratic sweep, it will take a while to deliver – probably not until February, after the inauguration. And there will be economical and oil demand repercussions between now and then; those that need the stimulus cannot contribute to activity simply because they know something’s coming months from now given most – if not all – in need are pretty much tapped out. 

And that’s not to mention it becomes a bit of an election pony race as to how much stimulus is in the pipeline, bringing us back into the most unvirtuous circle of the too-close-to-call narrative. Despite the media polls skewing Democrats, independent straw polls are not nearly so convincing. Fiscal prudence will now be a rallying cry for the Republican budgetary hawks and could provide a new arc for upcoming debates revolving around the Democratic dilly-dallying and spendthrift ways.

When a market is prepared for chaos, expect a lack of market chaos. Extreme volatility is a product of surprises, not desired outcomes.

Ironically, with a Blue Wave now getting priced in, the potential for market chaos has risen exponentially. While it’s fiscally bullish, the only thing about repricing a Biden win here is that it also increases the chance of a contested result. Volatility was far too low, given the possible turn of events. The latest surge in vol should still see more investors dive back into the most straightforward and conventionally sourced protection for election day: the US dollar umbrella.  

Oil Markets

Oil markets further declined after the American Petroleum Institute (API) reported a build in crude oil inventories of 951,000 barrels for the week ending October 2 and bearish against a consensus. It’s not exactly what the recovery doctor ordered as the oil market was already tanking from a two week high after President Trump quashed hope for a pre-election stimulus deal, exhausting all the optimism for a timely boost in demand while providing a market reality check that a run-up to an election is full of surprises. 

I guess the broader question is, with less than 30 days left, does it matter? I think it matters a lot to consumers who would have received an immediate fiscal put through at the pumps. And it matters immensely to an oil market in desperate need of an immediate fiscal put through to shore up the disheartening demand outlook due to Covid-19.

Still, crude prices are generally holding on to a good chunk of rebound prompted by President Trump's discharge from Walter Reed, supported by some exogenous factors, namely Hurricane Delta shuttering 29% of the GOM's oil output and a driller strike in Norway that’s limiting some supply.
However, these temporary supports are only papering over the real tragedy unfolding in the oil patch: a lengthy beat-down and tenuous recovery from a nasty epidemic where hotspots around the globe are still prevalent.

When BHP evacuated the Neptune and Shenzi oil fields in the GOM as Delta approaches, the December 2020 Brent 39.50/39.00 put spread trades traded pretty chunkily, which popped prices higher in New York in the morning session. 

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I think all risk will trade in tandem today to the beat of S&P e-minis and the US dollar, both of which best encapsulates the market primary nerve center. 

Currency Markets 

The USD dollar is back on yet another "safe-haven" binge as the risk-on mood got tripped up on the way to stock market nirvana when President Trump pulled the plug on a stimulus deal. 

Mind you, an assortment of tales was making the rounds, mostly of the after-the-fact variety, as to why risk appetite was moving higher, including relief about President Trump's health, hopes for a "big government" fiscal stimulus under a Democrat clean sweep scenario, or comfort that the election outcome might be sufficiently wide to rule out a contested result. But this morning’s market recoil should provide a stark reminder about the volatility that a bumpy election transition would bring.

The Euro 

The marco world is convinced of the Dollar's demise and has been expressing it by pilling into the Euro of late. Still, G-10 traders gathered the gusto and started to push back a bit harder ahead of 1.1800 after comments by ECB President Lagarde at a WSJ event reflected concern that new Covid-19 containment measures "will have an impact" "on the recovery. She reiterated that other policy tools are more effective than a rate cut, but stressed that the ECB had further room to cut rates.

Virus cases in Europe still on the rise, with some regions going back into full or partial lockdown. And with inflation diving, rate differentials on the move (bearish EURUSD), I can’t say I’m convinced the Euro will bounce significantly higher over the short term (1.19-1.20)

The British Pound 

The Pound briefly nudged above 1.30 overnight, but the limits of UK fiscal policy has become a more prominent narrative again. Yesterday the UK's Chancellor of the Exchequer, Rishi Sunak, said "hard choices are everywhere" about the fiscal conundrum of supporting growth during the pandemic while maintaining sustainable government finances.

The Chinese Yuan 

I was going to ramble again about how critical 6.68 is in USDCNH and that you should think to get out of you longs as it’s mostly late to the party types chasing this move lower. Still, I see smart money has already taken on that advice, taking the cross back to 6.75 which might be a better near-term comfort zone for the PBoC. But, for good measure, 6.6800 was a significant support line throughout mid-2019 (lows in February, March and April, before the launch higher). It makes sense from any tactical approach to reduce around 6.70, I think.

The Malaysian Ringgit 

US dollar safe-haven demand will likely thwart any near-term bullish ambitions with the oil price falling and risk unsettled after President Trump iced the stimulus deal. And with the Yuan slightly backpedaling overnight, I expect the ringgit to trade on the defensive mode.

The Australian Dollar 

The Australian Dollar will be an interesting test case as traders try to determine whether domestic/idiosyncratic stories matter at all in a world where all that matters is whether the reflation story is in ebb or flow mode. 

The RBA is incrementally creeping towards longer-end bond buying; Governor Lowe's speech on October 15 and the next RBA meeting (November 2) would typically be a significant event for a currency where the central bank is about to drop a big new program. It’s unclear now right now whether the USD lower / reflation / Asia rebound story is more important than the RBA. AUDUSD is the ultimate crosswinds trade (RBA bearish AUD, global variables bullish AUD).

Gold Markets

President Trump pulled the stimulus rug from under the market with predictable results getting expressed in the gold market. 

Gold was already selling off after ECB President Legarde’s dovish comments started to water down the EURUSD bullish run. Still, President Trump applied salt to the gold investor's wounds when he pinpricked the stimulus balloon that had been floating the gold market length. 

We’re back to square one again as far as the +1900 bump is concerned and likely back to the drawing board after another clear out of weaker longs.

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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