Fiscal MIA = More K

Eleanor Creagh

Australian Market Strategist

Summary:  As the US election draws closer, September market dynamics are being fueled by uncertainties surrounding the upcoming election, a 2nd round of fiscal stimulus MIA with congress in gridlock and Covid-19 cases on the rise again as the Northern hemisphere flu season fast approaches. The lack of near-term drivers in tandem with aforementioned will make it increasingly hard for stocks to recapture highs prior to the election.


Equities have continued their slide Thursday in Asia, following another jittery overnight session for risk assets with global equities falling and the S&P 500 ending lower by 2.37%. December e-minis remain above support at 3194, the 100 DMA, throughout Asia trade.

The dollar has continued to strengthen in a bid for the strongest week since April, adding to deleveraging pressures for risky assets across the board. Asian FX is feeling the heat of a stronger dollar. AUD in particular breaking lower being a risk proxy currency but also as the sluggish domestic economy and likelihood of persistently high unemployment sees the RBA easing policy further later this year, weighing on the currency. Dollar strength and poor risk sentiment also weighing on precious metals that continue to trade heavy, perhaps under-pricing the coming uncertainties and volatility backdrop that come hand in hand with the upcoming election chaos. Not least due to the higher probability of a contested result where the outcome is delayed. Gold at present on track for the 100 DMA which may see dip buyers step in as the longer term strategic proposition clearly remains intact.

Overnight Fed officials reiterated their pleas for more fiscal stimulus against a backdrop of persistent inaction from Washington. A concerning dynamic which will be negative for consumption down the track, the recovery momentum is too fragile to go without and monetary policy is pushing on a string. The cost of doing too little cements the multi-generational impacts of cratering wealth divides, entrenched by the crisis and present policy responses. The virus itself impacting minority communities and lower socio-demographics in a disproportionate manner, but also the crisis response exacerbating prior inequalities and wealth gaps within today’s society.

The K-shaped recovery bearing down on potential growth post crisis as millions in the real economy continue to struggle. Without the 2nd round of fiscal stimulus this cratering K-shaped dynamic worsens entrenching the divide between the “haves” and “have nots”. The contractionary effect of that negative impact on aggregate demand from the squeezed middle, coupled with industries mired by the crisis outweighing the gains in sectors whose relative attraction has increased. Of particular note in light of recent research suggesting that the income inequalities that have been supersized by the Coronavirus crisis pose long term risks for financial stability.

Elsewhere, President Trump citing fraudulent mail-in ballots once again reiterated his reluctance to relinquish the Presidential title.

Reporter: "Win, lose or draw in this election, will you commit here today for a peaceful transferal of power after the election?"

President Trump: "We're going to have to see what happens."

The President, raising the stakes on uncertainties surrounding the upcoming election and the legal challenges that may ensue, due to the high probability of a contested outcome. Conditions are ripe for a constitutional crisis of sorts and risk assets will struggle to price the eventual policy path under what could be an extended period of uncertainty.

However, the real question on everyone’s lips right now, whether the reversal of the explosive summer equity and precious metals rallies alongside a declining dollar, is a run of the mill correction or the beginnings of something more sinister. The answer likely lies somewhere in between with both economies and financial markets still in unchartered waters with the pandemic at the helm and unconventional policies in overdrive.

Source: Robintrack

These are not normal times in financial markets, speculation has been rife. A retail trading bonanza has ensued after years of being pre-conditioned to buy the dip in a pavlovian response to the “Fed Put” and the ongoing destruction of savings. August was a blow off top extreme fuelled by extreme behaviour in short dated options. A gigantic gamma squeeze higher in thin summer liquidity. In many ways this corrective move is just an escape valve for the wealth of frothy price action and excessive multiple expansion we witnessed throughout August as the Nasdaq powered higher in a parabolic move.

Source: Benn Eifert

Despite the 10% drawdown of recent highs, hedging activity has not picked up markedly.

Throughout history this has been a rare occurrence signalling perhaps an air of complacency remains.

Source: Twitter MacroCharts

However, in sympathy for complacency, the same underlying thesis remains intact that propelled risk assets off their March lows when the world was in the thick of the pandemic induced crisis. Central banks will not stop here and the determination of investors to hunt yield cannot be taken lightly.

Although, with the election uncertainties mounting, lagging fiscal and spectre of fresh lockdowns don’t expect a repeat of Augusts parabolic move higher. At this stage it is doubtful US markets can recapture highs prior to the election.

The Fed’s pain threshold may only be another 5% lower, the inexorable bubble being blown in risk assets leaves nowhere else to go. Fed programs have paused in recent weeks and there is capacity to add, with more tangible direction on QE a starting point following the lacklustre reaction in risk assets to the new AIT regime. Although, further actions undoubtedly representing the true definition of Albert Einstein's idiom on insanity.

"Insanity is doing the same thing over and over again and expecting different results.".

These are all temporary solutions exacerbating problems we cannot escape with present policy – like asset price inflation fuelling mounting social inequalities and wealth disparities, inter-generational inequalities, and the proliferation of zombie companies.

There is only so much monetary policy can do here and the US economy is in desperate need of more fiscal.

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