An ugly session for risk assets as the focus has firmly shifted toward de-risking ahead of the US election and what could be a volatile period for markets. The resurgence in the virus in the US and Europe also weighing on sentiment, with fresh lockdown measures in Europe set to hamper already plateauing recovery momentum. Both Germany and France announced partial lockdowns and Switzerland closed nightclubs whilst both Italy and Portugal reported record new cases.
The S&P 500 finished down 3.5%, the Nasdaq fell 3.7% whilst the Dow lost 942 points. FX markets also woke up to the deteriorating risk conditions and equity momentum with the JPY and USD gaining ground, the USD bid pushing DXY to a 2-week high weighing across the precious metals and commodity complex. Oil fell sharply as the spectre of fresh lockdowns weighs on the demand outlook.
Treasury yields were broadly unchanged in the face of an ugly down day for equities, raising some questions. Perhaps a risk-parity unwind or the spectre of persistent issuance, perhaps some hesitation on altering positions ahead of election week which entails heavy event risk, or perhaps treasuries are well and truly entrenched in the blue-sweep narrative and are holding their reflationary downtrend, for the 60:40 crew it’s time to find a new hedge. This could mean that with the fiscal impasse set to preside until 1Q21 that the fed will be back in action in a bid to substitute the fiscal MIA.
In contrast to the overnight moves the Asia trade has been relatively calm, regional cash indices are certainly seeing the follow through of the overnight selling on Wall Street, but losses are more tempered. However, the AUD is eking out small gains, JPY is underperforming and E-minis are bid fairly aggressively, but with the VIX now back above 40 trading ranges are expanded, 3% days, both to the upside and downside, the new normal whilst the VIX remains elevated. Focus to nights shifts to an expected dovish ECB (perhaps no respite for gold yet), US jobless claims data and the first reading of 3Q GDP.
Relative to the 3.5% drop in the S&P and corresponding spike in volatility, VIX now > 40, FX markets, credit and yields have responded with relative calm, possibly indicating a more focal equity-centric adjustment in the lead up to the election. Unsurprising with the uncertainty that shrouds the upcoming event risk, polling predictions and possible scenarios post November 3. The aftermath of the election will bring potential policy changes, or even more unknowns in the event of a contested result that in the worst case spills into scenes of civil unrest with one side of the electorate believing the election has been stolen. A scenario that would certainly see heightened volatility remaining part of the picture. For what it’s worth, my personal take, as outlined in our recent Q4 outlook, is a democratic sweep, with historic youth turnout playing a crucial role.
The Stimulus Gap
In addition, despite a throwaway comment from House speaker Pelosi on the stimulus front, "Pelosi Hopes Market Rout Pushes Trump Into a Stimulus Deal", any stimulus hopes should be done and dusted. The Senate has been adjourned until November 9 and the only way a package is passed prior to the 20 January inauguration is if Trump wins the presidential race. Post the election, if Trump loses, and further if republicans lose control of the Senate it is unlikely that a deal will be reached on additional aid, with no incentive for the Trump administration to corral Senate Republicans (Mitch McConnell and the fiscal conservatives) toward a deal. This leaves the stimulus impasse open until February 2021 in the best-case scenario, and worst case, even later if the Republicans retain control of the senate and any package eventually agreed upon would undoubtedly be a lot smaller. The ability for markets to “look through” the emergent stimulus gap is then all down to the senate race, which will be a key directional driver for risk assets post the election. For more on this please see “It’s all about the senate race”.
More from the Fed?
The stimulus gap and fast approaching benefit cliff with all pandemic related UI programs (PUA, PEUC, etc) set to expire on December 31st presents a concerning dynamic for the US economy. The impasse will be negative for consumption/investment in 4Q20 and well into 1Q21 dependant on the senate race, undermining the 3Q rebound. Recovery momentum is too fragile to go without the additional fiscal aid, with consumer and business sentiment weighed by both the virus and absent stimulus. Depending on how the fiscal MIA plays out post the election and the prospects of a larger fiscal package in 1Q21, we could see the emergent gap compelling the Fed to commit to further accommodative policy moves. This could potentially see the Fed expanding its purchases of long-dated Treasury bonds in a bid to tide the US economy over until another round of fiscal aid is delivered.
Although as we have said many times before, 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 (/global economy) is in desperate need of more fiscal.