Reflation Trade Back in Play as America Votes

  • The reflation trade is still alive and well as the US goes to the polls; the dollar rally failed at top end of recent trading ranges
  • Election day is today in the US; September factory orders and October auto sales will be reported; Brazil central bank minutes will be released
  • Sterling is recovering even as the economic outlook darkens; National Bank of Poland meeting was postponed two days until Friday ; Turkey reported October CPI
  • RBA cut both the cash rate and the 3-year yield target 15 bp to 0.10% but unexpectedly announced additional QE; Malaysia kept rates steady at 1.75%, as expected

The reflation trade is still alive and well as the US goes to the polls. Global equities are up, bond prices are down, and the dollar is weaker. We will be putting out a piece later today “What Are Markets Telling Us?” To us, it appears that markets are pricing in solid odds of a Blue Wave today, implying significant fiscal stimulus and debt issuance seen in 2021. Because of the perceived risks of another surprise victory by President Trump, we do not think the Blue Wave is fully priced in and so there is room for further movement if Biden does indeed win. That said, “there’s many a slip twixt the cup and the lip” and so these directional bets can quickly reverse. Markets should not be lulled into a sense of complacency and should instead be prepared for greater volatility across all markets over the coming days.

The dollar rally failed at top end of recent trading ranges.  DXY has again proved unable to break above the 93-94 trading range that has largely held since the start of October. With DXY likely capped around 94, the euro is moving back above $1.17 after testing support near $1.16.  Sterling will be helped by the positive Brexit vibe and is moving back above $1.30, while USD/JPY has been unable to break above the 105 area.  If dollar weakness picks up again as we expect, the pair should move back towards 104.

 

AMERICAS

Election day is today in the US. However, given the huge amount of mail-in ballots this year due to the pandemic, results may not be known for several days, if not weeks. The best case scenario for the markets is a unified government, with a Blue Wave preferable to a Red Wave due to the higher probability of aggressive fiscal stimulus. A split government (with Democratic president and Republican Senate or vice versa) would suggest continued deadlock and low probability of meaningful fiscal stimulus. That said, we think the absolute worst outcome is a contested election in which the results are not known for weeks and is ultimately decided by the courts. Markets hate uncertainty and this is the most uncertain outcome of them all. We will be monitoring election results all night and will provide analysis as needed.

September factory orders and October auto sales will be reported today. Orders are expected to rise 1.0% m/m, while sales are expected to come in at a 16.5 mln annualized rate. Yesterday, October ISM manufacturing PMI came in much stronger than expected. Headline number was 59.3 vs. 55.4 in September and was the highest since September 2018. Of note, the employment component rose above 50 for the first time since July 2019.

Brazil central bank minutes will be released.  Last week, the bank left rates unchanged at 2.0% and kept the forward guidance mostly unchanged. While the door seems to remain open to further easing, we think the next move in rates will almost certainly be up. That said, we think the curve is showing an overly aggressive tightening schedule, with nearly 50 bp already priced in over the next few months due largely to concerns on the fiscal/political side.  Next scheduled policy meeting is December 9.  October trade data will also be reported today.

 

EUROPE/MIDDLE EAST/AFRICA

Sterling is recovering even as the economic outlook darkens. There is little doubt that renewed lockdowns and the expiration of some government aid programs will be a headwind in Q4. While retailers are facing a four-week lockdown, government officials have hinted that its duration may have to be extended. The timing couldn’t have come at a worse time, as reports suggest 80% of annual profits for non-food retailers are generated during the holiday season of November and December. Of course, the impact will fall differently on brick and mortar stores vs. online retailing, but the net impact is clearly going to be negative for the economy. The Bank of England is widely expected to increase its asset purchases Thursday, please look for our preview tomorrow.

National Bank of Poland meeting was postponed two days until Friday. No explanation was given and the bank is widely expected to keep rates steady at 0.10%.  The bank has left rates steady since the last 40 bp cut in May. The delay in the policy meeting is raising speculation that the bank will announce further stimulus this week.  Government officials are now mulling a response to the rising virus numbers and may be coordinating with the central bank. Reports suggest nothing is being ruled out but they hope to avoid a nationwide lockdown. As it is, social unrest is already rising as anti-government protests spread.

Turkey reported October CPI.  Headline inflation rose 11.89% y/y vs. 11.97% expected and 11.75% in September.  Though slightly lower than expected, inflation still moved further above the 3-7% target range.  The lira has weakened 8% since the central bank’s dovish surprise October 22, with USD/TRY making a new record high today near 8.50.  As such, we see upside risks for inflation going forward.  Next scheduled policy meeting is November 19.  Backdoor tightening is starting to pick up, with the average cost of funding around 13.50% nearing the ostensible ceiling of 14.75%. If lira weakness continues, we think a large hike in all policy rates will be seen before that meeting.

 

ASIA

Reserve Bank of Australia cut both the cash rate and the 3-year yield target 15 bp to 0.10%, as expected. It did deliver a dovish surprise with plans to buy AUD100 bln (worth 5% of GDP) of 5- to 10-year bonds over the next six months and will be independent of its efforts to keep the 3-year rate on target. The RBA said it is prepared to do more if necessary, adding that it does not expect to hike the cash rate for at least three years, until inflation is within the 2-3% target range. The RBA added that the measures taken will contribute to a weaker exchange rate. The Aussie tends to strengthen on RBA decision days. Of the ten so far this year, AUD has gained on seven of them. The RBA will issue its quarterly Statement on Monetary Policy Friday in which it lays out new macro forecasts.

Bank Negara Malaysia kept rates steady at 1.75%, as expected.  A couple of analysts looked for a 25 bp cut to 1.50%.  The bank has left rates steady since the last 25 bp cut in July.  The bank noted improvements in the economy in Q3 but warned that targeted restrictions to control the virus are likely to hurt the outlook for Q4. CPI fell -1.4% y/y in September.  While the central bank does not have an explicit inflation target, it left the door open for further easing and downside risks should keep it in dovish mode for the foreseeable future.