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US Election Playbook: 3 outcomes for trading the market reaction
Election Night Volatility
Volatility, as viewed through the lens of the Vix, has already risen sharply in the lead up to the election but has been largely because of the surge in virus cases, and lockdown measures in Europe in particular, weighing on risk sentiment.
As far as the election itself goes, I think Trump is closer to victory than the pollsters, bookies and financial markets believe, which in itself favours election night volatility as states are called one-by-one, and a big response early Wednesday when European cash equities open to we would assume some clear result.
What also favours a large swing in futures pricing and in some FX crosses will be the way in which calls on individual states are made. With some states processing the in-person ballots before the postal ones are counted, and with some states allowing postal votes to arrive after Nov 3rd (as long as they are postmarked by this date), we could get an inaccurate and uneven sample when the West Coast polls close.
If the polls are correct and show a comprehensive Biden victory, volatility would likely ensue as investors call their accountants to assess their holdings in expectation of much higher taxes. FX crosses to watch will be focussed in the EM space (USDMXN, USDCNH among others) as a Biden win is seen as particularly positive for those currencies.
We’ve included three potentials outcomes (the fourth variant: Trump wins and Senate turns blue has been omitted since if there is a Trump surge it’s hard to see the Senate going Blue).
A little history: The stock market has risen under both Democrat and Republican presidents – stocks don’t really care who’s in charge. Moreover, ongoing monetary policy support underpins the equity market valuations – the Fed is not about to remove the punch bowl.
Whilst longer-dated Treasury yields have started to rise after a period of stagnation this appears to be on the expected increase in the money supply and fiscal expansion which would accompany just about any of the results. We should note that yields are very much within tight ranges and any significant break free to the upside would require a serious bout of inflation (as previously argued this may be the consequence of a vast increase in the money supply).
Fiscal stimulus is coming over the hill whatever the result – the only exception would be a contested result which would of course tend to create heightened volatility and a slower path to stimulus. Fiscal largesse will make a significant difference and we would tend to think that a Blue Wave result would support the largest fiscal expansion of the possible outcomes.
A Biden White House and GOP Senate increases the risk of delay, particularly if some of the new senators don’t feel like voting for huge increase budget increases. A disputed election would need to be resolved in the Supreme Court and Trump has just scored a big win with his new justice.
Whilst a disputed result is possible and would cause the most volatility, it is a) being over-egged since postal votes should not make a big difference in the key states and b) it certainly won’t come to the point where Trump refuses to leave office. Leaving the unedifying and frankly undesirable prospect of a disputed result aside, we can look at the three main possible outcomes and what these mean for the markets.
Red Rum: Trump win, Senate stays red
- Less stimulus – not the $3tn Heroes Act but something that is a little short of what the market had been hoping for. Removal of tax and regulatory uncertainty supportive of equity valuations, however.
- Nominal yields down and real yields more negative favours gold + growth stocks + multiple expansion: more upside for the S&P 500 with the removal of the expected increase in corporate and capital gains taxes and reduction in policy and regulatory uncertainty.
- Growth beats Value status quo
- Dollar could outperform in the near term with a strong post-election euphoric bounce until stronger economic, monetary and fiscal trends are reasserted and drag on USD – however, trade tensions could be a headwind for USD bears.
- Policies supportive of US shale and further drilling, increasing domestic supply. Less stimulus could be –ve for demand, therefore WTI prices could tend to fall, especially as it looks like the winter is set up for inventory builds. Global demand will matter more for commodities in general and even for oil there are greater forces at work than who’s in charge.
- Reinvigorated Trump with Senate support would likely see the president up the ante on trade, which would tend to be negative for emerging markets and boost the USD. It could also be a negative for European equities and the euro.
So Mauve: Biden win, Senate stays red
- Less uncertainty over policy likely to support equities, whilst a Biden presidency ought to see some degree of a reset with trade partners that would boost sentiment and corporate earnings.
- Stimulus delays could create near-term volatility but it would be in no one’s interests to drag their feet for long given any ballot box risk would be two years away.
- Tax uncertainty removed = +ve for equity valuations.
- Improvement in trade relations with partners and China could see EM supported as well as European equities/currency – would also tend to boost US corporate earnings
- Not as bad for the dollar as a Blue Steal result with trade reset likely to support flows, also less fiscal expansion a factor, but USD seen weaker in this outcome as part of broader downtrend.
- Little impact on commodities – arguably less stimulus creates headwind to recovery but broadly speaking the global post-Covid expansion will matter more, as well as the relative weakness of the dollar.
Blue Steal: Biden win, Senate goes blue
- It’s a reflation and redistribution thing – more stimulus = more spending + higher prices (tax reform nails the rich who have less marginal spending power than poorer folks)
- Timing is everything: do tax hikes get applied instantly and retroactively – which could spark selling into the year-end before stimulus floods through in the spring of 2021.
- Lots of stimulus is a +ve for stocks and favours Value stocks – less overall potential for the broad market but tilted in favour of Value again over Growth.
- Remember the fiscal expansion is two-fold: Covid relief and massive infrastructure boost.
- Rising nominal yields, steepening of the curve = bad for gold (unless and until inflation appears) + good for banks.
- Expected hike to corporate taxes and capital gains tax creates policy uncertainty and could generate additional volatility into the year-end as investors liquidate positions to realise returns prior to the tax rises.
- Higher corporate taxes and regulatory uncertainty increases risk premium for equities, whilst could see nominal yields rise and reduce the TINA appeal for equities.
- Seen as more negative for USD with fiscal expansion and tax/regulatory regime weighing on demand for US equities.
- Over the medium to long term, a Democrat clean energy push would restrict US output and reduce demand for oil products. Larger stimulus would boost demand near-term – also watch as to whether a Blue Steal result leads to a deal with Iran that brings more production onto global markets.
- Result likely +ve for emerging markets with dollar weaker, better trade relations – look to USDMXN, USDCNH upside in this scenario.
- Better trade relations with partners a +ve for Euro (see weaker dollar narrative) and for European equities, particularly cyclical names.
Key question that will remain unanswered on Nov 4th: Does the gigantic stimulus that Biden and company would unleash flood the US economy with too much liquidity at a time of strong economic recovery, creating inflation and leading to monetary policy uncertainty?
In other words, do we get so much fiscal stimulus that the Fed becomes cornered and is forced into hiking rates much sooner than planned?
Polling continues to show Joe Biden commanding a roughly 7.5pt lead nationally, whilst in the key battlegrounds, the lead is less than half at 3.4pts.
There are ranges and differences between states, but the broad picture remains that a Blue Wave is to be expected if we take the polling data as accurate. However, on a personal basis, my belief is that Trump has many ‘quiet’ supporters who do not show up in the polls, and many of whom will have been affected by the unrest over the summer. The Senate race is extremely tight right now but still indicate the Democrats just taking back control.
Latest Presidential polls as of Oct 29th, from RealClearPolitics (who power our election tracker):
|North Carolina||48.4||47.7||Biden +0.7|
Sector & Single Stock Volatility Picks
Within our Biden20 basket of stocks which could do well from a Democrat clean sweep, green energy stocks look most exposed to downside if there were a Trump victory since it would materially affect the expected regulatory backdrop for clean energy investment.
Biden plans to set the US on an “irreversible path” to net-zero carbon emissions by 2050, with an ambitious goal to build a carbon pollution-free power sector by 2035. The proposals clearly imply a far more aggressive shift away from fossil fuels than a Trump administration would pursue.
The proposals would also involve upgrading millions of commercial and residential properties over 4 years to increase energy efficiency, with among other things the installation of solar panels, which is a potentially huge growth area (Sunrun, Solaredge, FirstSolar in our Biden20).
We also note a positive policy position on EV (Tesla, Nikola) with plans to invest in 500,000 electric vehicle charging stations. European clean energy stocks would also benefit from a Biden win, whilst automakers like VW and Daimler could benefit too.
As far as the corporate tax agenda goes, there could be several companies who benefitted most from the 2017 tax cuts who see earnings cut in 2021 in the event of a ‘Blue Steal’ result. Among European stocks, those with a large exposure to US sales like Ferguson, CRH, Ashtead could see a reduction in EPS due to tax hikes – however, it is likely that massive infrastructure spending and stimulus would offer significant support to those names in particular.
Our Trump20 Blend includes some of the largest US stocks which benefitted from the 2017 tax cuts (and therefore could see the worst EPS haircut in the event of a Biden win and Democrat Senate).
These include Nvidia, Netflix, Salesforce.com, CSX, Boeing, Union Pacific and ServiceNow.
Mixed start for European equities, dollar retreats
A mixed start for European stock markets this morning with equities failing to struggling out of bed after yesterday’s session left indices in the red. The FTSE is really struggling to peel away from the 5,800 level, while the DAX either side of the flatline in early trade as investors try to make up their minds.
US stocks finished higher amid a choppy session on Wall Street. Ten out of 11 S&P 500 sectors rose as the broad market closed up 0.3% at 3,246 having tested the lows at 3.209, its weakest intra-day level since the end of July. When the selling at the open didn’t force further selling, there was an opportunity for dip buyers to come in. Nevertheless, the index is down 2.2% for the week still.
The Dow rose 0.2% but is –3% for the week. The Nasdaq also rose but is down –1% on the week and is on course for its fourth straight weekly decline, which would be the first such run of losses since August 2019. European markets are on course for 3-4% losses on the week.
Can stimulus and vaccine headlines prop up risk appetite?
Some positive headlines around a US stimulus deal and vaccine news may be supportive of risk today but sentiment is fragile, and it’s been a turbulent week – I think we need to see how it shakes out at the close for a better read on where the next move goes.
Whilst the market finished a tad higher yesterday, the S&P 500 keeps making new lows and sentiment seems to hinge around several downside risks. Right now, the up days are not as strong as the down days, which tells me momentum is with the bears for now. Any bounce we get needs to be seen in the context of a very sharp pullback on Monday and on Wednesday.
Until we clear last week’s levels – 3400 on SPX, around 3300 on Stoxx 50 and 6,000 on the FTSE, the bias looks to the downside for me.
UK facing jobs crunch despite new government scheme
For the UK, there is looming unemployment crisis, despite the government’s new jobs scheme. Whilst extending support for another 6 months, the chancellor’s plan will only help those in viable jobs – the crunch comes in November. Just how many are viable longer term? How many of the roughly 3m on furlough won’t have a job at Christmas?
Needless to say with all this support, UK public borrowing is soaring. This raises concerns about tax rises down the line to ‘pay for it’. But as previously discussed, deficits shouldn’t matter: rather than taxing the recovery and stifling it, the government ought to consider outright debt monetization, given the extraordinary circumstances we are in.
House Democrats prepare stimulus bill, Senate leader promises orderly transition after election
House Democrats are working on a $2.2 trillion coronavirus stimulus package – we’ve been before, so I wouldn’t assume it will pass. Indeed, House Republican leader Kevin McCarthy immediately dismissed the package, but we cannot rule it out entirely. Is this too much of a temptation for bulls?
Meanwhile, the nonsense worries about Trump refusing to leave the White House have thankfully been largely put to rest after Senate majority leader Mitch McConnell vowed there will be an orderly transition just as there has been after every election since 1792. However, I still believe the election will be contested and we are unlikely to know the final result on November 4th.
On the vaccine front, there more and more clinical trials happening. Sanofi says it is ready to produce 1bn doses of its vaccine with partner GSK from early next year. Dr Fauci sounded optimistic this week, telling Congress there is “growing optimism” there will be one or more safe and effective vaccines ready either by the end of 2020 or early 2021.
King dollar takes a breather, pressure off precious metals
The re-emergence of king dollar has been a big weight on stocks in the US – it’s no coincidence that the dollar reversed its slide at the start of September just as stocks rolled over. This in can turn can breed defensiveness in other regional equity markets.
The dollar index retreated from resistance around 94.60 – this is an important level with an upside breach calling for a return to 95. However, with the 14-day RSI rolling over this may be a time for a pullback and consolidation around the 94 region with a test of 93.70 on the cards.
With the dollar coming off its highs there has been some relief for precious metals. Both gold and silver seem to put in a near-term bottom after some nasty price action in recent days. Gold found support at $1,850 and rose to $1,870. Silver has rallied back above $23 after the $22 level held.
Sterling is finding bid with GBPUSD making solid progress towards 1.28 as the dollar comes off. Trend resistance above with the confluence of moving average and Fib support offering decent base.
Looking for clearance of 46 on the RSI for bullish signal. Look also at the bearish 21-day SMA crossover with the 50-day at the 1.30 pivot. The 38.2% retracement at 1.2690 is the major support after the 200-day EMA around 1.27650.
Risk rolls over in early US trade
Risk appetite has well and truly rolled over. US stocks moved lower in the first hour of trade and continued to leg it south, while oil prices swan dived amid a very messy picture for global markets on Thursday afternoon. Walgreens Boots Alliance shares dragged on the Dow as the stock fell 9% after reporting weaker-than-forecast earnings amid some serious weakness in the UK. The dollar found bid as risk appetite turned south, hurting FX majors like GBPUSD and EURUSD.
Supreme Court rules on Trump tax records
Risk sentiment was a bit shaky anyway but it seemed to take a hit as Donald Trump suffered a defeat at the hands of the Supreme Court – not his favourite institution of late. The Supreme Court ruled Donald Trump’s finances and tax returns are fair game and should be seen by the Grand Jury, but it threw out rulings that allowed 3 Democrat-led Congressional committees to obtain Trump’s financial records.
This ruling relates to alleged hush money to women who have claimed to have had sexual relations with the president – a story Mr Trump said was irrelevant. That may be so, but his tax returns may interest voters. Whilst US legal proceedings are far from my area of expertise, I understand that if only the Grand Jury sees the documents it is very unlikely that they would become public records, which could have had serious repercussions for the election. Meanwhile Treasury Sec Steve Mnuchin was also on the wires, saying the Federal government would not bail out states that had been ‘mis-managed’.
Stocks, commodities lower despite solid US jobs figures
The move lower came despite some decent jobs numbers. Weekly initial jobless claims fell to 1.314m, better than the 1.375m expected and representing a decline of 99k from a week ago. Continuing claims fell to 18.06m, a drop of almost 700k and much better than the 18.9m expected. The previous week’s number was also revised down over half a million.
So, the picture in the US labour market is maybe not quite as bad as feared, but still horrendous. There is clearly a long way to go before getting back to pre-pandemic levels. Moreover, as the number of covid-19 cases rises across most US states, the numbers may well start to improve a slower rate.
At send time indices were at session lows, making new lows for the week – we could see further declines as risk appetite appears to have rolled over today. As of send time the Dow was down over 1.8% to 25,559 at the session low, whilst S&P 500 was down 1.5% at a low of 3,120, making it down for the week.
The dip on Wall Street added to pressure on European equities with the FTSE 100 down over 1.7% to a low at 6,046, taking it negative for the week. Having been bid up on Monday towards the higher end of the recent ranges for little reason we are seeing indices pull back closer to the middle of the June ranges – no conviction trade yet.
Dollar firms against pound, euro in risk-off trade
Meanwhile, sterling eased back as risk appetite soured and Michel Barnier said talks this week confirm that significant divergences remain between the EU and the UK. Sterling pulled back from its highs at the top of the new bullish channel on the news as well as the general risk-off tone but remains in a solid uptrend with GBPUSD ably supported above 1.26. Elsewhere in FX the risk rollover boosted the USD so EURUSD pulled back under 1.13.
WTI (Aug) fell sharply from around $40.50 a low under $39.30 in a very swift and long-awaited reversal – albeit probably a day late given yesterday’s inventory build. Expectations of a slower reopening in a number of US states is a worry for near-term sentiment and I have been calling for a reversal based on the technical set-up, which could see a return to the neckline at $35.
Equities in retreat as Covid-19 cases advance, oil drops
Equity markets have come under pressure again as a spike in new Covid cases across the US has investors worried, whilst the IMF drastically cut its growth forecasts for the year. Major equity indices have retreated towards the lower end of the range traded in June but have yet to make fresh lows for the month – when they do it will get very interesting and could call for another leg lower.
Stocks in Europe were down 3% on Wednesday, whilst Wall Street dropped 2.6%. European markets opened lower again Thursday, with a risk-off trade seeing all sectors in the red and telcos, healthcare and utilities declining the least.
Investors are pulling their heads in a little as the surge in cases raises concerns about how quickly the US economy can emerge from the ashes. There are also clusters in Germany of course but the focus is on the divergence between the European and US experience. The FTSE 100 retreated close to 6,000 round number but found support around the 23.6% retracement at 6,066.
The S&P 500 closed at 3,050, on the 38.2% retracement. With softness on the open in Europe and futures indicating a lower open, we may see SPX test its 23.6% level on the 3,000 round number. A retest of the June lows looks increasingly likely.
IMF cuts global outlook, US-EU trade tensions simmer
Meanwhile the IMF lowered its 2020 outlook, warning the global economy would shrink a lot more this year than it had forecast in April. Global output is forecast at –4.9%, vs –3% in April. The UK and EU will decline 10%, whilst the US economy will shrink 8%. Tellingly, the IMF also lowered its 2021 bounce-back forecast – growth globally is expected to rally 5.4%, vs the 5.8% forecast in April.
In other words, the decline will be deeper and the recovery slower; that is, no V-shaped recovery. We can also add US-EU trade tensions into the mix hitting stock market sentiment, as the White House has threatened fresh tariffs. I’d also suggest that the closer we get to the election and the more polls show Biden leading Trump, the greater the risk of a Democrat clean sweep, which will need to be priced into equity markets.
Improved virus response, central bank stimulus lowers risk to equities
Although we see clear headline risk around spikes in Covid cases for equity markets, any second wave is not going to result in the same level of lockdown restrictions endured in the first wave: it’s just too costly economically and because we have learned a lot in how to cope with this virus, both in terms of treatment and prevention. This means any further pullback we see, whilst potentially quite sharp, is unlikely to see a retest of the lows in March.
Meanwhile central bank stimulus is still strong. The Fed has shifted materially – it now has a $7tn balance sheet, setting a floor under the bond market that pushes up equities. The risk to equities comes later in the year when we get a real insight into both the pace of economic recovery and, by extension, corporate earnings – does the S&P 500 still justify x23 forward PE, or should it start to trade at more like x19? The current forward PE of around x23 suggests hope of a bounce back in earnings next year that may not come to fruition.
US weekly jobless claims in focus
On the pace of economic recovery, today’s weekly jobless claims report will be of great significance. Last week’s underwhelmed. Following the surprisingly strong nonfarm payrolls report, the weekly numbers didn’t follow through with conviction – initial claims were down just 58k to 1.5m, whilst continuing claims only fell by 62k to 20.5m. The slowing in the rate of change was the main concern – hiring not really outpacing firing at a fast-enough pace to be confident of a decent recovery. I would like to see a greater improvement given the reopening of businesses, and it suggests more permanent scarring to the labour market.
Gold eases back as dollar recovers
Gold eased back off 8-year highs as the US dollar gained on the risk-off trade, but at $1765 in early European trade had bounced off lows around $1753 struck overnight. Short-term we see a stronger dollar exerting some pressure on gold prices; longer term the focus is on US real rates, which have just risen a touch off the lows. 10yr Treasury Inflation Protected Securities (TIPS) eased away from 7-year lows at –0.66 to –0.64, providing another little headwind to gold prices in the near term.
Oil slides on rising stockpiles
Crude oil declined with the broader risk-off trade. Rising US stockpiles – which hit a record high for the straight week – have also started to spook traders. Crude inventories climbed 1.44m barrels in the week to June 19th, to 540.7 million barrels. Gasoline stocks were down 1.7m barrels, giving encouraging signals about driving demand. US crude oil refinery inputs rose 239,000 bpd to 13.8m bpd. Total US production rose 500,000 bpd to 11m bpd due to the return of Gulf of Mexico output following Tropical Storm Cristobal.
WTI (Aug) retreated off the $40 level to trade just above $37 – as suggested whilst the fundamentals have started to build in favour of stronger pricing, the market will not be immune to a technical pullback on overbought conditions and/or a decline in sentiment among traders due to rising US cases. The emerging double top is less nascent than it was and increasingly calls for the $35 neckline to be touched. A breach here calls for $31.50, the swing lows touched in the second half of May.
In FX, we can see a downwards channel for GBPUSD. The cross has pulled back to 1.24 as the dollar found bid, before paring losses a little this morning. Bulls need to clear the swing high at 1.2540 to break the downtrend, but trend resistance appears around 1.25 first. Bears can eye a pullback to under the Jun 21st low around 1.2334, with the channel suggesting we may see a 1.22 handle should the bulls fail to break 1.25 next.
Stocks grind higher, dollar squeeze continues
The S&P 500 is down less than 5% for the year and is 40% above its pandemic trough, whilst the forward price-to-earnings multiple has risen to a two-decade high at 22.4. US GDP is seen falling by an astonishing 52.8% in the second quarter, according to the Atlanta Fed.
Whilst this number is always up for a lot of debate, it’s clear the contraction in the second quarter is going to be massive. Something has to give – but perhaps not yet.
Stocks are continuing in a grind higher with major indices marking new post-trough peaks and global stocks catching up with the US market, whilst the dollar continues to be sold in an unwind of the Covid-inspired rally. The lifting of lockdown restrictions combined with enormous central bank support means investors are shrugging off little things like collapsing GDP and worsening US-China tension.
The FTSE 100 cleared last week’s peak and extended gains on the open this morning to trade around 6290, through the 50% retracement of the peak-to-trough decline. Bulls are now looking to close the gap back to the March 6th 6400 handle.
IAG, InterContinental, Tui and Carnival are the top gainers, indicating all you need to know about this rally – deeply oversold stocks finding bid on hopes that travel restrictions are easing across the globe, particularly in Europe. Having wrestled with the 61.8% retracement, the DAX has cleared its own hurdle with the 200-day moving average now below as it advances beyond 12,100.
The S&P 500 moved to 3,080 and is now eyeing up the March bull trap double-swing highs above 3100 where the market came off and tried to rally before the main collapse.
FX market news: dollar retreat continues
In FX, majors are advancing steadily against the dollar and risk proxies are doing well with the Aussie and Kiwi trading at levels not seen since Jan/Feb, before the crisis really hit. Sterling continues to make ground up as GBPUSD approaches 1.26 and eyes a breach of the Apr double top, which could open up the path back to 1.30. EURUSD has risen above 1.12, breaking above the 61.8% retracement, which clears way back to the 50% line at 1.1450. The dollar index slipped further after breaking down at the 61.8% retracement.
Of course, sterling is also exposed to Brexit risks and on that front, there does seem some vague optimism that this week could see progress. I wouldn’t hold my breathe. The UK services PMI will show little improvement from last month as the survey is yet to capture any kind of lifting of lockdown restrictions. Next month’s survey will be important to show how quickly confidence is returning.
Today’s other data: US ISM non-manufacturing seen at 44.2 vs 41.8 previous, ADP nonfarms expected at –9m. Then it’s time for the weekly crude oil inventories from the EIA, which are expected to show a build of 3m barrels.
Crude oil rises on hopes OPEC will extend record production cuts
Crude oil continues to make new highs with prices advancing on hopes OPEC+ will agree to keep its deepest level of cuts in place for longer. OPEC and Russia will decide tomorrow whether to extend the 9.7m bpd of cuts carried out in May and June, which were due to be tapered to 7.7m from July.
Additional voluntary cuts by Saudi Arabia, UAE and Kuwait actually took headline cuts to 11m bpd in June, although we know compliance of 75% in May offsets the extra. If OPEC+ fails to agree to extend these cuts the market will be liable to sell off sharply. Even a one-month extension might not be enough, even though of course it would help rebalance oil markets more quickly.
WTI (Aug) rallied before losing steam at $38 as a draw on US crude oil inventories also buoyed bulls. Whilst the focus is still on the EIA figures today, API numbers showed a draw of 0.483m barrels compared with a build of 8.7m barrels last week.
Could this be the biggest monetary policy meeting in years?
Could the upcoming Federal Open Market Committee (FOMC) be the most watched monetary policy meeting in a long time?
It certainly has a lot weighing on it.
Stocks are at record highs, pushed higher by a certainty that the FOMC will cut short-term interest rates for the first time in a decade this week. The two-day policy meeting kicks off on Tuesday, with a policy decision announced on Wednesday.
While Chairman Jerome Powell signalled a cut in July, its unclear what the policy could be for the rest of the year. And is a cut even necessary? While the consensus is that a cut is coming – the only quibble is 25bps or 50bps – the recent economic data looks strong. As our Chief Markets Analyst, Neil Wilson, explains:
“Is a cut justified? I would point to underlying core CPI at 2.1%, retail sales +3.4% in June and a 50-year low in unemployment as perhaps arguments to the contrary. Increasingly there is a sense that the Fed is no longer data dependent, but being held to ransom by the White House and the market.”
But what can we expect from the meeting?
The answer is, it depends…
Confirmation of a cut from the FOMC, if paired with signals of a more dovish policy in the long term could send greenback diving.
On the flip side, if the markets are surprised and a cut doesn’t happen, expect stocks and commodities to tumble and the dollar to surge.
At this stage, despite stronger-than-expected data, growth momentum is weaker. While a recession has been avoided, a cut is still the safe bet. This policy meeting could define the direction of global monetary policy for years to come and provides a lot of opportunities for traders. One thing’s for sure, the announcement on Wednesday is not one to miss.
Gold & bitcoin firmer, stocks and dollar softer
Stocks and the US dollar were softer whilst gold and Bitcoin continued to drive higher as markets look ahead to the G20 meeting.
Stocks have eased as markets look ahead to the G20 meeting – optimism is fading a little and we would expect investors to perhaps take some risk off the table ahead of the meeting, particularly given the recent bump. Bear in mind also this is a weekend meeting that implies gap risk.
The S&P 500 eased 5pts yesterday to finish on 2,945. Asia has been softer overnight. Futures indicate European shares are lower today since there is really little fresh catalyst for bulls before we learn more about the Trump-Xi meeting in Osaka and what this means for global trade, tariffs et al.
US trade supremo Robert Lighthizer spoke to Chinese Vice Premier Liu He on Monday, at least paving the way for talks to take place in Japan. The FTSE 100 might struggle to hold the 7400 level today.
The US has hit Iran with more sanctions. No sense of de-escalation, but also no material worsening in the situation. The tensions offer short-term support for oil still with Brent steady around $64 and WTI shade below $54.
Gold firmed again overnight as we see the path to more gains being cleared. Gold hit a fresh six-year high amid a perfect blend of supporting factors. Four things are really driving gold – falling yields, a weaker dollar, a soft macroeconomic outlook and geopolitical risks rising in the Middle East.
Prices hit $1438, breaking resistance on $1433 before paring those gains to trade around $1426 at send time. Looking to break $1446 next.
Gold has huge negative correlation with real yields, which have come right down. US 10yr around 2%, now back to where they were in 2016 – if it goes lower, we would expect further gold strength. The surge in negative-yielding debt is undoubtedly key to the rally, and can be viewed as similar to the rise in gold prices and negative yield assets in 2016.
The dollar remains on the defensive. The dollar index has dropped further to trade around 95.50.
Sterling can’t catch much bid – GBPUSD remains off its lows around 1.2750 but is failing to make real inroads versus the greenback as Brexit uncertainty weighs heavily. Short positioning has eased but this remains a crowded trade.
We have the no-deal exit risk of course – Boris Johnson has said he is prepared to take Britain out without a deal come October 31st. But we also have General Election risk – chatter about a no-confidence vote being supported by a dozen or so Tory rebels could lead to the government falling and inevitably an election. Boris Johnson could end up the Lady Jane Grey of Downing Street if that were the case. This introduces risks of a) Brexit delay and ongoing political uncertainty, b) a hung parliament with no clear route out of Brexit, and c) a Corbyn-led Labour government that would be very risky for UK assets and equites.
The euro is faring better, with EURUSD up to regain the 1.14 handle, trading at 3-month peaks.
Bitcoin firmed again, cementing the gains above $11k. I would reiterate the comments from yesterday – it’s a hard market to stand in front of when it builds momentum like this. The buzz and the hype has returned. You can talk about Libra, or the halving next year, more and more institutional interest and so on, but ultimately this is a bubble again. Look for $11,600, the highs from Feb last year as offering the big test.
Trump’s Mexican standoff rattles investors
A Mexican standoff is one in which there is no strategy that exists that allows either side to gain victory. Donald Trump may take note.
Any hopes May would end on a high were dashed as the White House slapped tariffs on all goods from Mexico. Tariffs of 5% will take effect Jun 10th, and could rise to as much as 25% by October. The intent is to ratchet pressure on Mexico to stop illegal immigration to the US.
Coming at a time of a breakdown in talks with China, it’s another blow to bulls and we should consider further downside risks from escalation. The worry is who’s next on Trump’s list – the EU may be next.
A fight with its neighbour and largest trading partner was not on the agenda. With all eyes fixed on China, and with Nafta 2 agreed and all apparently all hunky dory on the Mexico front, the caprice of Trump has caught investors off guard and will weigh on investor sentiment.
Trump has weaponised trade and economic might of the US. We have to assume that talks with China are going nowhere, and that this therefore – in the absence of being able to find a new stick with which to beat Beijing – is Trump finding a new ‘enemy’ to attack.
It’s early yet but following yesterday’s steadying of the ship, futures in the US are off south again and a retest of the 200-day moving average on the S&P 500 seems assured. Dow futures are printing a 24k handle and are on course to close sharply lower for the month. Sell in May and go away turns out to have been accurate this time. You’d have anyway wanted to see a much firmer rally yesterday to suggest the bottom had been found.
Futures show European equities are retreating on this fresh trade threat and it’s set to be a down day. FTSE 100 key support at 7150 and may well get taken out today.
FX: Peso hit
Needless to say the Mexican peso plunged on the news and will now be sensitive to news flow on any escalation of tariffs, or likewise, any detente. USDMXN has broken up through 19.64 and is trading very near the highs of the year from Jan. Peso bears will have the 20 handle in their sights.
Japanese auto stocks were hit as they use Mexico as base to import to US. Mazda, Nissan, Toyota among the sharpest fallers. This is likely to have some read across for European carmakers in today’s session.
Havens that had briefly retreated amid yesterday’s more upbeat session, are once again bid. USDJPY has fallen through support to find the 108 handle. Gold has rallied through $1294 even as the relative safety of the dollar left greenback just a few pips from two-year highs.
GBPUSD has held the 1.26 handle but, having broken through this level and below last week’s lows, the pound is now sensitive to further downside squeezing as uncertainty over the next prime minister and the direction of Brexit persists.
Overnight data is not helping risk today. China PMI figures slipped to 49.4 against 49.9 expected, signalling contraction in factory activity again. The PMI data suggests China is feeling the heat from the trade war and tariffs. Caixin PMI is due Monday and May show an even steeper contraction.
The whole picture is bearish for oil. Crude prices are at three-month lows. US inventories yesterday showed a smaller than expected drawdown at just -282k versus -860k expected. Stockpiles are at their highest in two years. Speculative long positions continue to be cut. Supply uncertainty is losing out to demand uncertainty. Simply put, with OPEC and co curbing output, there is ample excess capacity in the market should it be needed, so supply worries can be overstated. Traders are also betting Permian offtake constraints will lessen as the year goes on. Copper’s also been slipping and is retesting the Jan lows. Commodity markets are telling us there’s trouble in the global economy.
Uber losses hit $1bn but this was at the lower end of guidance, whilst revenues came in at the top of the guided range at $3.1bn. Top marks for that, but fundamental questions remain over top line growth in bookings.
Quarter on quarter bookings growth of a mere 3.4% is a worry, and shows how tough this market is becoming. Costs rose 35% from a year ago, whilst grids booking revenues were up 34%. Monthly active users jumped to 93m from 91m. Nevertheless these were solid results in line with management expectations, which should give investors some confidence
Little help for rangebound yen likely from Bank of Japan commentary
The Bank of Japan releases its Summary of Opinions and monetary policy meeting minutes this week. Policy normalisation is moving at a glacial pace, so the safe-haven yen is unlikely to find support on the latest comments from policymakers.
Central banks around the world are tilting towards the dovish end of the spectrum. This is epitomised by the futures market’s pricing in of a rate cut from the Federal Reserve this year. However, when it comes to caution, the Bank of Japan is the archetype – it was the first to implement quantitative easing and continues to pump trillions into the economy while tinkering with the yield curve and keeping rates negative.
The plan is unlikely to change any time soon, especially now that global conditions appear to be weakening. There is little certainty on a macro level to suggest the BOJ’s work is anywhere near done, even if the fears of a worldwide recession that tanked markets at the end of 2018/beginning of 2019 were overdone.
This leaves the yen facing more of the same; a narrow trading range against its major peers.
USD/JPY edges higher as fears over US growth fears ease
The US dollar has been slowly pressuring the yen lower over the course of the past few months. Strong US data has helped ease fears over the need for the Federal Reserve to pivot too severely into dovish territory.
EUR/JPY rangebound as ECB and BOJ battle for dovish crown
The EUR/JPY pairing was almost slap-bang in the middle of its multi-week trading range at the time of writing. While the European Central Bank could bring quantitative easing back into play later in the year, which would be yen-supportive, the long-term outlook remains that it will be the weakening of overseas policy outlooks that push JPY higher in the near-term, not the machinations of its own BOJ.
Yen unable to take advantage as Brexit uncertainty keeps pound floored
GBP/JPY is just a pinch overbought on the Relative Strength Index. The chart above shows how the pairing has settled into a narrow channel over the past few weeks. Brexit uncertainty is keeping sterling on pause, however the yen is unable to capitalise on this due to the lack of optimism surrounding Japanese monetary policy.