After what appeared to be a raft of consensus trades about to go kaput in the absence of a "blue wave," FX and other asset markets decided to ride the blue wave mirage anyway. Odd? You bet it is. But I think some underestimated that the US dollar could sell in any election scenario – even more so as the world turns cold on US treasuries. If reserve managers, pension funds, and most notably China, continue to shun USTs, it cannot be suitable for the long-term US dollar view.
The rally in US equities is very impressive. Perhaps the street had underestimated just how much cash had been raised over the past few weeks and how eager investors would be willing to put it to work diving back into the "lower for longer" interest rate trade, which has categorically been one of the rallying cries of this enduring bull market cycle.
Instead of no-wave lead balloons, the market continues to float on the lower for longer policy balloons. Indeed, the president is on the line as 99 ("central bank policy") balloons go by.
There is some momentum behind this as the market seems to like the outlook for moderation (Biden/GOP combo). We went from unwinding the blue wave trade Wednesday to flipping the risk-on switch Thursday.
Now, what does Freaky Friday have in store? I suspect it will be a day of consolidations with fast money folding their hands as the US election winner could be announced over the weekend – and who knows what happens from there.
Most striking about the election aftermath is the extraordinary divergence between equities and fixed income. Stock investors seem entirely comfortable with policy gridlock, while bond investors got smacked by the mirage of the blue wave. Equity markets' impressive ability to switch narratives and stay optimistic, almost regardless of the outcome, suggests continued high resilience. But in fixed income, one needs to err on the side of caution here, assuming that the position clean-out might have pushed things too far, particularly if we get hit with positive vaccine news. For now, though, gold and a weaker dollar might be a safer bet.
But even on the vaccine front, what if it doesn’t provide the game-changing panacea? One thing that is starting to worry me is the market is unprepared for vaccine faux pas. On every market street corner traders seem to be talking along the lines of "when there is a vaccine" with little consideration of the ones in trials proving ineffective or for a rollout that is not as smooth as hoped. To that end, AstraZeneca has fallen short of its target to deliver 30mn Covid-19 vaccine doses to the UK by the end of September and will be able to supply only 4% of what it promised by the end of the year, according to the head of the government's vaccine task force, the Financial Times [paywall] reports.
The oil market weighs the possible impact of more significant restrictions on domestic US oil and gas production from Joe Biden's presidency versus more support for energy transition and the probability of re-engagement with Iran. The latter seems the most significant risk for the oil price, but it’s unlikely that it will be a priority for the first year of a new administration.
By far, the most critical questions for oil are how quickly a Covid-19 vaccine is widely available, whether a US stimulus deal can be achieved in a fractious and uncertain political environment, and how OPEC will respond to demand concerns. I suspect if the market knew with any degree of conviction how any of these critical-for-oil price dominos would fall into place, traders would likely stop riding the Covid curve roller coaster, which tends to crest peaks quickly and drops even quicker.
But as we head to end yet another roller-coaster week in the analysis of oil trading, one would have to think it is encouraging that OPEC+ continues to signal that the group will do what it can to backstop the oil price while we wait for the demand outlook to improve.
Asia FX provides the best front-row seat to currency markets vagaries. With the street crafting a "risk-on" spin to the increased likelihood of a gridlocked US Congress, the US dollar has turned weaker amid this "risk-on" mood, with lower US yields perhaps also adding to the downside.
But The Bank of Canada, RBA, and yesterday the Bank of England, joined the chorus of central bankers that are quickly learning that QE has precisely zero impact on their currency. The FX market has decided a pound, a dollar, or a euro of QE is not worth what it once was.
With rates at the ZLB, as we have been harping the last few weeks, it makes sense that QE now has a limited impact on rates and no impact on the currency. Unless the central bank is willing to go profoundly into negative interest rate territory, QE has less impact on interest rates, bond prices and currency markets. The LZB is the effective floor and is a shock absorber for long rates and buffers downward yield momentum. The Fed buying US bonds at 4% in 2009 was one thing; the RBA buying 5-year bonds at 0.24% is quite another.
The Japanese Yen
JPY is catching up with the general USD weakness on the break of that crucial 104.00 level held numerous times over the last months, which appears to have been triggered by the drop in US yields supporting the thesis that the weaker dollar might be the easiest hedge to sit out until the election dust settles. But this is quite a significant technical break, and JPY could have room to strengthen. My choice, given the negative Europe rising virus cases, would still be EURJPY. The pair topped out twice in the last couple of days ahead of 123.20.
The Malaysian Ringgit
The ringgit is trading better due to the weaker US dollar but still lagging regional peers heading into the budget day. This comes at possibly the worst time when the coffers are running dry due to the lack of petrol dollars. The country is in dire need of emergency allocations to boost the economy and fight off the latest Covid surge's negative impact.
Gold has rallied hard on the back of the weak US dollar and falling US bond yields as the yellow metal is attracting its lion’s share for "safe- haven" appeal – even as there were fewer changes in yesterday's Fed statement than in any other I have seen. Thursday's policy decision, though, was unanimous, while Kaplan dissented in the September meeting.
The Fed reiterates that it’s committed to using its full range of tools, says economic activity continues to recover, and that overall financial conditions remain accommodative; it’s all 'steady-as-she-goes' from a monetary policy perspective. It would have been very premature to take any signals for expected election outcomes at this point.
There’s a massive band of resistance extending from the $1,960 level to the $2,000 level, so in the absence of any inflation spark one needs to err on the side of caution here, assuming that the bond position clean-out might have pushed things too far (lower yields)
So, any signs of momentum exhaustion will be more than likely be viewed as an opportunity to profit.
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