Now What?

The dollar fell hard last week.  After several failed attempts, it broke below JPY104 for the first time in eight months.  Despite Beijing's ostensible efforts to moderate the yuan's upside pressure through various administrative policy adjustments, it reached new two-year highs.  The Mexican peso, the second most actively traded emerging market currency after the yuan, returned to levels not seen since the March chaos.  The Dollar Index fell from the upper end of its range (above 94.00) toward the lowest end of its range (~92.00).  Our newly launched Bannockburn World Currency Index advanced by the most since March to reach its best level since early 2019. 

The volatility as the US polls closed on November 3 gave way to several sustained moves.  The push lower in the dollar and yields and higher equities may mark the resumption of underlying trends.  The Bank of England and the Reserve Bank of Australia launched the new round of easing, which did not prevent their respective currencies from participating in the move against the greenback.  The ECB has committed itself to ease next month.  The Bank of Japan and the Federal Reserve appear in no hurry to ease policy further.  

Nearly all the major central banks are advocating more fiscal support.  The Bank of Japan and the Federal Reserve recognize that their current efforts can be scaled, if needed, but seem to be skeptical of the value of pushing rates down a little more.  In the US, the 30-year fixed-rate mortgage benchmark fell to new record lows after the election last week (2.78%).  If the Fed were to succeed in driving it to 2.5%, would it have a material impact, goes the argument.  The BOJ saw the world's third-largest economy contract for three consecutive quarters with a modest response compared with other major central banks and has not taken fresh initiatives for nearly eight months.  

On the eve of the election, the US Treasury indicated that it penciled in a $1 trillion fiscal stimulus next year.  A day after the election, the current Senate Majority Leader McConnell said a stimulus that would include state and local aid should be completed before the end of the year. However, many are skeptical  Treasury also announced plans for the third consecutive record refunding.  It will raise $122 bln in the holiday-shortened week:  ($54 bln three-year notes, $41 bln 10-year notes, and $27 bln 30-year bonds.  It will boost the other upcoming coupon auctions, and next year, it plans to increase the sale of inflation-protected securities and floating-rate notes. 

The market is not simply a sophisticated casino, as some seem to think, but a large aggregator and discounting mechanism.  Sure, the polls were suggesting a Democratic sweep was possible, but as soon as it was evident that this was unlikely (see Dade County, Florida), the markets adjusted quickly, even violently so.   As the great Danish philosopher Kierkegaard noted, and his observation applies to the markets equally: Life can only be understood backwards, but must be lived forwards.

Two main forces appear to be at work.   First, while individual portfolios may vary, global benchmarks paused in recent months.  The MSCI Asia Pacific Index was moving broadly sideways until last week.  Europe's Dow Jones Stoxx 600 peaked in July and was at five-month lows at the end of October.  The S&P 500 peaked in early September and finished October at the lower end of a three-month trading range. 

It appeared that once the election passed, even if the results were not fully known, the pent up demand was expressed.  The MSCI Asia Pacific Index rallied more than 6% last week to set new highs for the year.  The Stoxx 600 had its best week since 20121,  rising about 7.0% last week.  The 7.3% rally of the S&P 500 was the best since the rebound in March and April.  

The second consideration was the election itself.  The conclusion, perhaps hastily drawn, was that the political outcome would temper the next stimulus's size, reduce the amount of Trump's tax cuts could be unwound, and dilute some of the strong positions that some saw as anti-business.  Control of the Senate may be decided by run-off contests in early January.   The Democratic majority in the House of Representatives was pared.  It means that the general environment will be more pro-business than anticipated when the Blue Wave seemed a reasonable scenario.  

Partisan rhetoric aside, a record number of Republican women will be in the new Congress and President Trump drew the most non-white votes of a Republican presidential candidate in a generation.  He appeared to increase his support among nearly every demographic group but white groups.  The progressive, internationalist, secular values that many associate with the American elite seem to have lost their mooring with a significant part of the voters, even if not a majority.   

US 10-year interest rates trended higher last month.  The increase seemed to reflect real and anticipated supply, though, of course, with the average rate inflation target announced, some may be tempted to give the nod to the Federal Reserve's forward guidance.  The yield jumped to five-month highs near 0.95%, just before the polls began closing in some east coast states.  As soon as a sense of the outcome gleaned, the yield began tumbling and fell to almost 0.70% before stabilizing ahead of the end of the FOMC meeting on November 5.   

These larger issues and the pending supply will likely overshadow the US October inflation gauges. Both the headline and core CPI are expected to have risen by 0.2% last month.  If true, then the headline rate may slip to a benign 1.3% while the core ticks up to 1.8% from 1.7%.   A similar pattern is likely in the PPI, where the year-over-year headline rate has been dampened by the drop in energy prices this year.  The headline and core pace may have held steady at 0.4% and 1.2%, respectively.  

China will also report October inflation.  The consumer price environment has been masked by food prices but with a waning effect. The softness of core prices may The deflationary risk is materializing, and it may prompt a policy response from the PBOC even if not immediately.  China's consumer prices rose at a 4.5% year-over-year pace at the end of last year and accelerated over 5% in January and February.  It fell below 2% in September and is expected to have fallen below 1% in October for the first time in three years.  Deflation in producer continues at around a 2% pace but is likely to gradually moderate in the coming months.  

A few other data points will command attention next week.  Japan's reports October machine tool orders, which will allow a check on capital expenditures at the start of Q4.  Included in the balance of payments report, Japan includes country-specific bond flow, which has been interesting. Japanese institutional investors bought a record amount of Italian bonds over the summer.  Rarely has the US 10-year premium over Japan been so small (70 bp), and the currency hedge is expensive (selling dollars).  

The UK has a busy economic calendar, with employment, industrial output, trade, and culminating with the first look at Q3 GDP.  Recall the economy contracted by nearly a fifth (19.8%) in Q3.  Like most other economies, it snapped back powerfully in Q3.  The median forecast in the Bloomberg survey is for a 15.8% expansion.  The headline may pose some risk,  but with a new lockdown in place, it is not an indication of what is happening now.  Indeed, the BOE warned that output will fall by 2% in Q4 (previously +3.5%) and that the unpreparedness of small businesses for Brexit can shave one percentage point off of Q1 GDP.  The UK-EU trade negotiations resume as the next deadline approaches in the middle of the month.  

The eurozone's data, which includes September industrial output and trade figures and another look at Q3 GDP, is frankly of little import.  First, the first estimate of Q3 GDP  (12.7%) is good enough.  A small revision is of no consequence.  Second, the GDP data neuters the high-frequency data from September. Perhaps most importantly, events have superseded the data.  The surging virus and lockdowns, social restrictions, curfews, and recommendations (Sweden) will take an economic toll, even though it should be less severe than the previous one.

The ECB has already thrown down the gauntlet.  It has committed itself to ease policy in December alongside the new staff forecasts.  If it were to merely increase and extended its Pandemic Emergency Purchase Program by around 500 bln euros and extended it through the H2 21, the market might be disappointed.  The ECB's word cues suggest easing on more than one channel.  Other channels could include making its Pandemic Emergency Long-Term Refinancing Operations more attractive.  The minus 25 bp attached to the recent operation saw a milquetoast reception as many of the same counterparties can borrow under a different facility that lends at minus 100 bp (Targeted Long Term Refinancing Operation).  The ECB could cut rates.  Reports suggest that the reversal rate, the level of negative deposit rate that actually becomes counter-productive, is thought to be closer to 1%.  

Meanwhile, there has been progress on the EU Recovery Fund.  It appears that compromises have been struck that will secure the approval of the European Parliament.  However, the next hurdle may be more daunting.  The vast majority want to link aid to fulfilling commitments on other EU goals, specifically, the rule of law.  It is clearly a stick to punish Hungary and Poland.  The rub lies in the unanimity required for approval.  

Risk-appetites are unlikely to be shaped much by the high-frequency economic data in the days ahead.  After last week's big moves and anticipation of more monetary and fiscal stimulus in the coming months, market positioning may frame the investment climate for the next few weeks.  The ECB is set to ease policy before the Federal Reserve, and the market may be cautious about taking the euro much above $1.19 immediately.  Japan's Prime Minister Suga and central bank Governor Kuroda spoke out after the dollar fell through JPY104 about the importance of currency stability.

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