It has been one volatile week for the markets, with risk assets recovering from a weak start to turn positive as we head towards the weekend. Unless something changes dramatically late in the day on Friday, precious metals and the major stocks indices were on course to end higher for the second consecutive week. Likewise, the dollar index was heading lower for the second straight week as foreign currencies rallied amid ongoing risk-on sentiment. Financial markets became even more sensitive to stimulus talks in the US, as evidenced by (1) the wild swings in nearly all asset classes in response to the every-changing situation in Washington and (2) with precious metals, for example, having been unable to decouple themselves from other assets like equities. As stocks and gold have continued to trend in the same direction, in FX it has been all about the riskier currencies making good ground against both the dollar and Japanese yen – currencies considered to be safe haven. In short, risk has remained on the table despite so much uncertainty out there. Investors have largely ignored the second wave of COVID infections across Europe.
Stimulus hopes to be main driver behind risk
So, heading into the week ahead, the key takeaway point from this week is that sentiment has been dominated by events on Capitol Hill, with everything becoming all about stimulus. This is likely to remain the case as the Presidential election draws ever closer. Thus, the week’s upcoming economic data may not cause too much volatility as the “risk-on, risk-off” remains the dominant trading theme. Granted, things like Brexit will be important to monitor if you happen to trade the pound, but this is unlikely to impact the wider markets. Rising virus cases may also be shrugged off again, unless deaths and hospitalizations jump (see below for more).
Large scale stimulus back on?
It looks like Donald Trump is leaning toward a large-scale stimulus bill again, after pouring cold waters on it on Tuesday, when he tweeted that talks will be put on hold until after the elections. However, the US President has been keen to bail out individual parts of the economy hit hardest by the pandemic – only the Dems were not up for it. So, it is back to square one again.
They have talked the talk now they need to walk the walk. Indeed, there is a real risk that nothing might happen again in the weeks ahead, as large differences remain between the two parties. That is why it is important that traders should remain nimble and take things from one level to the next and move on to the next best opportunity, as all it takes is a tweet for the markets to dump.
Investors warming to potential Biden victory
As a blue wave and Joe Biden victory increasingly becomes likely, the markets have been calm. Very calm, in fact. The VIX has been dropping and stocks rising.
It almost appears as though elections are cancelled. Investors are evidently not too concerned about the prospects of higher taxes and heavier regulation under a Democratic government. Instead, they remain hopeful that a victory for Biden may actually mean more government spending as the Dems have shown in their willingness for a large stimulus package. Does this imply that in the event of – what would be – a surprise victory for Trump, the markets may not react too positively this time around? Well, if a bi-partisan agreement on stimulus is not agreed upon before the election, then it is likely that the Republicans will opt for a smaller package if Trump is re-elected. This may disappoint the markets. So, the initial reaction to a surprise victory for Trump may not be positive, as investors price in lower government spending.
The calmness of the markets may also be due to the fact, that as Biden’s lead continues to grow in the polls, investors are pricing out the prospects of a messy contested election result.
But are investors being irrationally too optimistic and under-pricing risk?
Vaccine hopes keeping the bears away – for now
Another reason why volatility has been fairly muted despite the upcoming US presidential election, as well as Brexit- and coronavirus-related uncertainties, is that a vaccine for COVID-19 might soon become approved, easing concerns over another large-scale lockdown and lifting expectations of a boosted recovery. This implies that at least in the short-term, any potential corrections are going to be short-lived.
Second wave causes record daily infections
However, several European countries have again registered new record spikes in new daily virus cases, causing the French government to order the shutting of bars in more cities and Spanish government to issue a 15-day state of emergency to help bring down infections in capital Madrid and nine surrounding cities. Meanwhile Poland reported the third consecutive daily record spikes in virus cases, while Russia had its worst day ever as it registered 12,126 cases in the past 24 hours.
So far, death rates have thankfully remained low in this second wave. Hospital beds and ventilator capacity is also sufficient in most developed countries to cope with new critically ill COVID patients for now. But if hospitalizations rise rapidly then stricter measures will likely be announced by governments, and this will almost certainly cause a spike in risk aversion in the markets. So, watch the deteriorating situation closely, even if optimism is on the rise that a vaccine might be around the corner.
Indeed, the impact of the second wave has already been felt by some economies. The UK’s economic expansion in August was the weakest of the pandemic period, as GDP rose only 2.1% instead of 4.6% expected. Industrial production and construction output also rose less than expected.
Key macro events in the week ahead:
Among the week’s scheduled data releases are Chinese trade figures, Australia’s employment report and US retail sales. There is also a Brexit deadline. Here are the week’s data highlights:
US investors will be away on Monday in observance of Columbus Day, while Canadians will be celebrating Thanksgiving. There isn’t any major scheduled economic news from Europe, although Bank of England’s Bailey and Haskel will be speaking.
: (1) Chinese trade figures
, (2) UK jobless claims and (3) US CPI
The Chinese yuan has been one of the strongest currencies as investors bet that a China-led recovery will take shape. China’s trade figures will thus have important implications on this viewpoint, especially in the event of a major surprise. The data will also reveal the strength – or lack thereof – of foreign demand.
The Fed has already said they will look through short-term price changes, which makes the CPI print less of a market-moving event than it was previously
: (1) Eurozone industrial production and (2) Central Bank speeches by several Fed officials including Clarida, Quarles and Kaplan, as well as BoE’s Haldane, BOC’s Lane and RBA’s Lowe.
: (1) Australian employment and (2) US jobless claims among a handful of other second-tier data
After the RBA’s message of concern over the labour market, Australia’s jobs situation will need be monitored closely. Although the AUD/USD has risen sharply along with other risk assets, any surprisingly sharp weakness in employment data will fuel expectations of an imminent RBA easing, which could cause at least short-term weakness in this pair.
: US retails sales and Brexit deadline
The last day of the week will end with the publication of the latest retail sales, along with a few other macro pointers from the world’s largest economy. But will the market care? Clearly, most of the focus will be on stimulus and upcoming presidential election.
Also in focus on Friday, and for much of the weeks ahead, will be Brexit. The Prime Minister’s initial deadline for talks is Friday. Boris Johnson has agreed to extend talks by a month, only if there is clarity by the end of the week, after warning that if no progress is made then he will exit the talks early.