- The negative virus news stream is weighing on sentiment; implied volatility measures are starting to move higher, especially in the equity space; the dollar is bid today
- Stimulus will have to wait until after the election, if at all; there are two election scenarios that would likely lead to fiscal expansion; early voting figures continue to come in at a rapid pace with some 70 mln votes cast
- Canada and Brazil are expected to keep rates steady; Turkey central bank released its quarterly inflation report
- Harsh lockdown measures by France and Germany will weigh on the economic outlook; we are becoming increasingly concerned about anti-lockdown protests across the region; Spain reported September retail sales
- Australia reported Q3 CPI; USD/CNY fix today at 6.7195 was the highest since October 16
The negative virus news stream is weighing on sentiment. Harsh lockdown measures by France and Germany are being taken (see below). Here in the US, hospitalizations have risen at least 10% over the past week in 32 states while infections are at a new third peak. It’s clear that the global economic outlook for Q4 and perhaps beyond is deteriorating rapidly and there’s nothing that fiscal and monetary stimulus can do at this point. Fed Chair Powell (among others) has been steadfast n his message that there cannot be a sustainable economic recovery until the virus is controlled. Asian and European stock markets are in the red, as are US equity futures.
Implied volatility measures are starting to move higher, especially in the equity space. As we mentioned last week, we still think there are plenty of reasons for investors to seek protection ahead of the US elections given the myriad potential risks ahead. Between the virus resurgence in Europe, Brexit, and the rising geopolitical tensions rising in many places, it’s hard to see how anyone would have a strong risk-on conviction at this juncture. We think the odds of all these individual risk events resolving with favorable outcomes are good, and yet taken together there are a lot of opportunities for things go wrong.
The dollar is bid today. Yet the lack of a really big move higher in the dollar in the midst of this week’s risk-off environment is telling. DXY has moved back into the 93-94 range that held for most of October but we do not foresee a breakout to a higher range. With DXY likely capped at 94, the euro is likely to see near-term support near $1.17 while sterling should hold above $1.29. USD/JPY continues to sink and is nearing a test of the September low near 104. If risk-off sentiment persists, a test of the March low near 101.20 seems likely.
Stimulus will have to wait until after the election, if at all. President Trump said, “After the election we’ll get the best stimulus package you’ve ever seen.” House Speaker Pelosi said her committee chairs continue to work on stimulus legislation, but White House Spokesperson Farah said that the administration’s focus is on a package that can be assemble “within weeks.” Trump later said “I’ll always talk about it. Because our people should get it.” Much will depend on the election results.
There are two scenarios that would likely lead to fiscal expansion. Biden plus a Democratic Senate would most likely lead to very aggressive stimulus, which we think will be dollar-negative given the greater twin deficits and accelerated Fed balance sheet expansion needed to mop up record UST issuance to prevent a spike in long-dated yields. Trump plus a Republican Senate would likely deliver fiscal stimulus but on a much smaller scale. This would also be dollar-negative over the short-term, but both would set the table for a dollar recovery if the US can start to outperform again. The last potential outcome of a split government (Biden plus a Republican Senate or Trump plus a Democratic Senate) would likely lead to gridlock and forced austerity, translating into a weaker dollar though a worse growth outlook (perhaps after a knee-jerk risk-aversion dollar rally).
Early voting figures continue to come in at a rapid pace with some 70 mln votes cast. This is equivalent to about half of total turnout from the 2016 elections. Considering the states that report party registration (over 30 mln votes), Democrats account for 50%, Republicans 30% and the remainder as no party registration. To be clear: this does not guarantee that votes will come in according to party registration. Betting odds have narrowed for Biden over the last few days, both for the presidency and Senate, but remain within the month’s range. The US reports September advance goods balance (-$84.5 bln expected) as well as wholesale and retail inventories (0.4% m/m and 0.5% m/m expected, respectively).
Bank of Canada is expected to keep policy steady. At its September 9 meeting, the bank kept all policy settings the same but removed language that it is prepared to add more stimulus if needed. While promising to continue QE at its current pace, the bank said it would be “calibrated.” While that suggests the bank is considering some sort of tapering as the economy improves, it won’t happen anytime soon. Indeed, with virus numbers rising, the BOC is expected to reiterate the need to keep rates lower for longer. The Loonie tends to strengthen on BOC decision days. In the last 12 meetings dating back to last July, the currency has weakened on only 3 of those days.
Brazil COPOM is expected to keep rates steady at 2.0%. Mid-October IPCA inflation came in at 3.52% y/y, the highest since mid-March but still in the bottom half of the 2.5-5.5% target range. Despite the bank’s dovish forward guidance, the CDI market is pricing in a potential 25 bp hike at the December 9 meeting followed by hikes of 25-50 bp in H1 2021. This strikes us as too hawkish and perhaps partially reflects fiscal deterioration risks.
Harsh lockdown measures by France and Germany will weigh on the economic outlook. Reports suggest that France will enact a one-month lockdown starting this week. Though not as stringent as the first-wave lockdowns, it is still a significant step up from more localized and lighter measures taken before. In Germany, Merkel’s government is moving towards a one-month shutdown of bars, restaurants, and leisure facilities, along with personal contact restrictions. The case count in Germany has been rising rapidly, but it’s the death rate in France (highest since April) and in Italy (highest since May) that is much more concerning.
We are becoming increasingly concerned about anti-lockdown protests across the region. Italy had violent clashes between demonstrators and police in Rome, Milan, and Turin. In Spain, the far-left and pro-independence party CUP organized protests in Barcelona, which followed earlier protests from the service sector. The UK has also seen intensifying protests, with several arrests in London and demonstrations in many other cities.
Spain reported September retail sales. Sales came in at -3.3% y/y vs. -3.4% expected. France reports September consumer spending (-1.4% m/m expected) Friday, along with German September retail sales (-0.5% m/m expected). Eurozone retail sales won’t be reported until November 5 but those readings from the two largest economies will provide some final clues. With lockdowns intensifying, sales in Q4 are clearly subject to downside risks. The ECB will have to acknowledge the deteriorating outlook at its meeting Thursday, please see our preview here. We expect an increase in asset purchases at the next meeting in December.
Turkey central bank released its quarterly inflation report. Inflation forecasts for 2020 and 2021 were raised to 12.1% and 9.4% from 8.9% and 6.2% in the July report, respectively. These forecasts are higher than the government’s of 10.5% and 8.0%, respectively, and suggests the bank is preparing for more tightening ahead. After the bank’s dovish surprise last week, the lira has gone on to record new all-time lows against the dollar and the losses are starting to go exponential. Next scheduled policy meeting is November 19 bit we think an emergency rate hike could come at any time as this sort of move in the lira is unsustainable. Treasury Minister Albayrak said yesterday that there are no plans for capital controls.
Australia reported Q3 CPI. Headline inflation came in at 0.7% y/y vs. 0.6% expected and -0.3% in Q2, while trimmed mean inflation came in at 1.2% y/y vs. 1.1% expected and 1.2% in Q2. At its last meeting, the RBA “agreed to maintain highly accommodative policy settings as long as required and to continue to consider how additional monetary easing could support jobs as the economy opens up further.” The CPI data does nothing to prevent such a move. A cut at the November 3 seems very likely at this point, with the futures market implying nearly an 85% chance, according to the Bloomberg WIRP model.
USD/CNY fix today at 6.7195 was the highest since October 16. It was the first fix since the PBOC tweaked the process. By removing the counter-cyclical factor at a time of yuan weakness, the central bank is signaling that it will not lean against that weakness. Taken along with other measures such as the suspension of IPOs on the Shenzhen exchange, it’s clear that excessive yuan gains were becoming a concern. As it is, this current bout of risk-off sentiment is doing the job nicely, with the yuan weakening along with wider EM.