US equities recovered Wednesday, the S&P up 1.7% heading into the close after the US President walked back from his walk-away on fiscal negotiations with Democrats. After the US close Tuesday, the President pressed stand-alone household stimulus payments and support for airlines. For their part, Democrats don’t care.
Handwringing about those fiscal negotiations has been a common theme among Fed speakers in recent weeks, and was also reflected in the September FOMC meeting released overnight: "many participants noted that their economic outlook assumed additional financial support and that if future fiscal support was significantly smaller or arrived significantly later than they expected, the pace of the recovery could be slower than anticipated."
The prospect of the Democrats sweeping all three levels of government continues to support stock markets in the run-up to the election day, which would put the Democrats in a position to all but a rubber stamp an energetic fiscal stimulus bill while lavishing the county with significant investment in health care, education and infrastructure. The only way traders will shift from this bias is if Trump recovers in the polls which would hurt reflation trades.
According to FiveThirtyEight, the recent shift in US presidential election polling for Florida is surprising, with older votes breaking towards Joe Biden in droves. The most recent polls given Biden a three-to-five point lead, which translates to a 66% chance of carrying the state. Georgia is fascinating to watch as well. Although President Trump is just in front, Biden has been closing the gap; there hasn’t been a poll in Georgia since September 27, suggesting the Biden bounce is yet to be reflected.
Indeed, the debate about what’s in the price seems to be moving way past the November election as expectations for a Democratic sweep grow. It’s perhaps dangerous to draw that straight-line market conclusion so early as there’s bound to be more pitfall and pratfalls along the way with President Trump looking to take back control of the election narrative and put the ball back in the Democrats' court. Hence, in the absence of any other suitable hedges for those eventualities, VIX appears to be the only game in town, thus it remains elevated.
However, risk sentiment improved at the margins on optimism that Trump's stand-alone $1,200 stimulus parachute becomes a reality. Indeed, that income support would be immediately channeled back into the economy, which could use a boost Q 3 stagnating recovery notwithstanding
Why the VIX is up
But really, why is volatility going up when stock markets appear to be in a happy place and the polls are skewing blue? Of course, a big chunk of the implied vol is a hedge against election time pitfalls and pratfall, along with a contested result; let us not forget that volatility goes up when yields go up, direct and straightforward.
That makes perfect sense, but to anyone saying higher yields will hurt the stock market at some point, that’s not how it usually works: higher yields at this point in the cycle signal reflation, not Fed hikes. Reflation is good for stocks. Higher bond yields are only bad for stock markets when you’re worried about the Fed hiking too much. And that’s a story for 2025.
I’m surprised we have the Fed pleading for fiscal stimulus and US fiscal talks halting on the same day, yet the stocks don’t care. That tells me this is a regime shift pricing unfolding, which is all about the blue wave tsunami.
Trump's tweetstorm "proposal" is tiny and cannot justify the market turnaround – unless markets believe it signals he’s ready to reopen negotiations.That’s doubtful, but stranger things have happened.
Anyway, it looks like stocks are happy to play the waiting game. After all, Trump win: good for stocks. Biden win: good for stocks. So keep buying, it would seem.
But, ultimately, the market seems to have settled on the idea that a Biden win is bullish stocks, too, as the return of stability and the promise of MMT-style spending outweigh any concerns about future corporate tax hikes.
On the other hand, I believe we’re going to have a massive, gnarly, correction post-election similar to the 2018 December debacle on a Democrat clean sweep that would prompt a "risk-off" mood as concerns about higher taxes and tech regulation outweigh hopes for higher government spending and a less aggressive tone on US-China trade relations. So, don’t let go of your VIX or long US dollar hedges too early on the build-up euphoria – after all stimulus only temporary papers over the cracks while the fissure continues to grow.
Supply-driven commodity rallies are incredibly fragile and it’s even more so for oil in a Covid environment, as evidenced by the constant choppiness of price action this week. Hints of any renewed downtrend in demand – practically driven by Covid concerns – continue to send fear across the markets. As a consequence of tepid demand, we could see inventories remain elevated for some time.
The weakness in crude oil persists as the prospect of a fourth US stimulus package fades, but prices received some support from a draw in product stocks in the DOE data, which offset small crude build.
Hurricane Delta is still on track to hit the Gulf of Mexico this weekend, and about 30% of oil output has been shut down. However, Delta has been downgraded to a category two hurricane, lessening one of the current support pillars.
But in Norway, one of the oil workers' unions said it would expand its strike from Thursday to include four more North Sea fields, for a total of 11 oil fields, unless a wage deal is reached. Around 330k barrels a day have already been lost to the strike, and this last move is expected to add about 170k more.
The USD is mostly steady against G10 FX, although the recent underperformance of the JPY has extended. Yesterday's market angst prompted by President Trump's decision to end fiscal negotiations until after the election was soothed by his later tweets advocating fiscal support for airlines and the Paycheck Protection Program.
The FX market looks happy to trade the ranges, while risk appetite considerations will drive initial responses.
The Japanese Yen (feature currency)
USDJPY went on a bit of a tear after clearing offers around recent highs at 105.70/80 and is trading back in the daily Ichimoku cloud of 105.85/106.18. A close above could be seen as a bullish technical sign, but there are some excellent resistance levels ahead:
Flows have not supported the price; net, there was some cross-JPY selling last week, but the flow is neutral overall this week with volumes slightly down compared to last. It could be a squeeze rather than a change in direction, but the reflation input signal via bond markets could be the telltale.
The Democratic blue wave outcome's asset-market impact will likely focus on the effects of more lavish fiscal spending, which could drive a bear steepening in the UST curve that encourages USDJPY upside.
EUR-USD is steady this morning, held back perhaps by weaker than expected German data and further Covid-19 containment measures.
The British Pound
It’s hard to get excited about GBPUSD as mini-rally attempts continue to falter amid souring headlines around Brexit, while the prospect of negative rates loom ominously on the horizon.
The Malaysian Ringgit
Ringgit trading has been relatively lifeless as traders monitor the resurgence of Covid-19 in Malaysia, which has prompted some tightening of current social mobility rules around safer health practices. We could see another lackluster session with the Golden Week holiday in China and quiet trading in general as traders are content to sit on their hands this week and watch the US election chaos unfold.
The Thai Baht
On the THB appreciation, I feel the market has priced in the negatives. With Thailand's current account surplus creeping higher, extensive moves to improve tourism, the cheapest REER in a long time, and positive carry to be short USDTHB given elevation of points, the downside risk is clear.
FOMC Minutes Reveal Overshoot Debate
Even though the FOMC retained optionality to hike before an inflation overshoot, the minutes showed that if financial stability was a concern, they continued to double down on rate guidance even as incoming data improves. In general, participants wanted to maintain some flexibility, not to corner themselves should conditions change. Hence, several others said there didn’t appear to be a need for enhanced forward guidance at this juncture.
It seems that, for now, participants are looking at their remaining tools as options to use if things get worse. They are assuming that fiscal stimulus is coming, even if it comes later than expected, so they may not feel a need to use the tools until there’s clarity on that, one way or another.
The gold market reaction to the minutes was quite telling. It’s become more evident in the past month that the Fed will not provide additional accommodation in the short term, or even remotely to think about going below zero. Fed Evans had already told us the FOMC could raise rates before the 2% inflation target is met. And despite the gold-friendly reaction function implied by lower for longer, the lack of rapid inflation put through could see investors cashing out their cold coins for fear of higher US yields.
I thought we would see a more significant bounce in gold with equities and cyclical stock higher. The yellow metal seems to be falling out of favor again and maybe getting dissuaded by the rise in US yields and the lack of follow-through on US dollar selling, particularly against the Euro.
I still think bullion finds its short-term legs as there should be enough volatility from the election, particularly from retail investors, to aid gold. Also, a stimulus package is not permanently off the table; on the margin, this will be gold supportive and there should be good demand towards the 100-day moving average around $1,958. That said, it’s hard to be overly excited at the upside, either. Yields are still high enough to provide the ultimate rally capper.
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Sometimes you have to throw conventional wisdom out the door and just let the good times roll