European stocks indices rebounded sharply on Friday and were fast erasing their weekly losses at the time of writing. Meanwhile the major US indices were all somewhat more comfortably holding in the positive territory on the week, now up for the third consecutive week and mirroring a similar performance for Chinese markets. Reflecting the relatively more subdued sentiment across Europe, benchmark government bond prices in Germany, Italy, France, Spain and UK all rose more noticeably than in the US, this week. Crude oil and copper were unable to build on the back of last week’s sizeable rallies, while gold and silver were also struggling as the dollar index attempted to halt a two-week slide, thanks to weakness in the euro, pound and commodity dollars, and despite the falls in bond yields.
Markets heading to the new week in more upbeat mood
Barring a late-day sell-off on Friday, when this report was written, it looks like investors were feeling more upbeat ahead of the weekend than they did earlier in the week, when the rapid increase in coronavirus cases in Europe triggered lots of new restrictions and raised concerns over the economic recovery. But on Friday hopes over a vaccine rose after Pfizer said it could seek emergency-use authorization for its Covid-19 vaccine in the US by late November, provided the shot is shown to be effective. Also helping to offset growth concerns on Friday were the surprisingly stronger readings on US consumer sentiment and retail sales, adding to the better-than-expected earnings results from US banks earlier in the week.
Investors warming to potential Biden victory
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 larger 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 they being irrationally too optimistic and under-pricing risk?
Virus and restrictions pose risk to stocks
While there is hope that a vaccine may be approved soon, a growing number of European countries have been taking urgent action to try and stem the spread of the virus as deaths have started to climb and hospitalisation in the UK has risen above the March levels. So far, we haven’t seen national lockdowns, but large cities in Europe have introduced new restrictions, including curfews. If the virus continues to spread and take more lives, more draconian measures may have to be implemented. So, the situation needs to be monitored very closely and things could change over the weekend, which means there is the potential for the markets to gap at the open on Sunday night.
Meanwhile as was the case in the first wave, the US could also be heading towards a second wave of infections like Europe. New virus cases here have topped 60,000 for the first time in more than two months, on Thursday. If the rate continues to climb, then US states may tighten restrictions furthers, crippling the economic recovery. Consequently, stocks may start to come under renewed pressure.
Brexit talks likely to drag on
On Friday, the UK Prime Minister Boris Johnson declared talks between the UK and EU over a post-Brexit trade agreement "over,” with Downing Street adding that there was "no point" in discussions continuing next week, unless the EU made fundamental change in their approach. The EU is willing to intensify discussions but will not agree to a deal "at any price". However, Boris Johnson did not say he’s walking away from negotiations completely and so talks will most likely resume in the week ahead, despite him saying discussions are over.
Central banks could become vocal on more stimulus
As US elections near, virus cases and deaths rise and Brexit uncertainty increases further, the stock markets may become more and more volatile in the weeks ahead as concerns grow over the economic recovery. As a result, central banks will likely become more vocal about providing additional monetary support in the weeks ahead. Underscoring this view, we have already seen benchmark government bond yields drop noticeably again, especially for European countries:
Source: ThinkMarkets and TradingView.com
If bond yields continue to fall, this should boost the appeal of lower-yielding or non-interest-bearing assets, such as gold and silver. But what about the euro, given the increasing risks of COVID-related restrictions across Europe, not to mention subdued economic activity and the potential for upcoming data releases to turn weak? The single currency may struggle at these levels if the ECB's easy-going attitude towards growth changes. Consequently, there is risk that the euro rally may unravel as investors price in the prospects of even looser monetary policy.
Key data and earnings for the week ahead