The acute stress from the COVID-19 pandemic has started to fade, at least for now. This has allowed markets to shift its focus to other issues such as in upcoming US elections.
The emergence of centrist Joe Biden as the Democratic nominee and questions around the administration’s handling of the COVID-19 crisis has given a hit to President Trump’s re-election chance. This swing in sentiment also has important down ballot effects for the House and Senate with betting odds for Republicans to hold the Senate falling from 74% in March to 54% currently. Clearly a Democratic sweep of Congress, combined with a Biden victory will give Democrats substantial policymaking control.
This is important as the next administration will be tasked with moving the US forward from a massive economic, social and health shock. The US will be faced with an unprecedented economic backdrop of extraordinarily high deficits and a possibly compromised growth environment. Moreover, the president and Congress will play a major role in future fiscal policy, a rethink of structural aspects of the economy—think healthcare and the medical supply chain—and when to exit emergency programs.
With the policy gap between Democrats and Republicans widening, the stakes are even higher. Case in point, Senate Leader McConnell advocates for states to be able to declare bankruptcy while Pelosi supports a federal bailout. This philosophical split will likely carryover to the debate over the recovery and the fiscal path forward.
Thus far, the USD hasn’t reacted much to the increase in political noise but that doesn’t mean the dollar is immune. More likely, the muted reaction reflects how early we still are in the election process and the uncertainty around the ultimate outcome. What is clearer is that the election is now more consequential. Pre-crisis, Biden was seen as a relatively neutral outcome but post crisis, and with a Democratic sweep in play, a Biden presidency could signal material shifts in economic policy.
The euro finished last week lower and the view remains for further weakness. The global outlook remains weak and the Eurozone should have a deeper recession than the US. Fiscal policy response has been weaker out of Europe (fiscal stimulus averaging 2% of GDP vs. 9% in the US). Additionally, while markets have embraced the Fed’s QE infinity, it questions the ECB’s ability to stimulate the economy. Unless EU leaders are able to come to an agreement on a strong support package, the dichotomy of a strong response in the US vs. a weaker one in Europe supports the US economy and the USD recovering faster than Europe and the euro.
The bias remains for GBP to move lower. While economies are starting to reopen, uncertainty, lack of confidence and second infection wave risks will keep the rebound weak. This leaves the UK in the disadvantageous position of needing foreign financing with low growth and no interest rate advantage. Moreover, Brexit talks resume this week but little progress is expected. Both sides remain far apart and the UK maintains that it will not request an extension as time runs out to request. The base case remains for an extension, but the longer this takes and the closer we get to the extension deadline, expect the markets to price in a risk premium.
Risk ended last week on a positive note as a call between the US and China reaffirmed that both sides will work towards meeting Phase 1 obligations. Domestically, Japan will start its first full week after its Golden Week holiday. This means that fund outflows to invest in foreign assets should pick up again although the extension of the national state of emergency should dampen this a bit. Expect USDJPY to remain range bound as it gets pushed by optimism around re-opening and pulled by negative economic data reflecting COVID-19 headwinds on the global economy.
While Canada’s jobs report beat expectations, it was more of a “less bad” than “outperformance” situation. Over a two week period, Canada still has a massive loss of jobs. Moreover, job loss as a proportion of the labor market is greater in Canada than the US. The outlook still remains for the Canadian economy to be uniquely vulnerable given dependence on services and oil that should exacerbate the country’s weak BoP position.
In last week’s Week Ahead publication, we expressed the view that CNY weakness should be faded as no one wants a reescalation of trade tensions with the global economy weakened by COVID-19 headwinds. This played out at the end of last week with a phone call between the US and China resulting in “good progress.” Domestic activity has picked up, but external demand for Chinese goods remains weak with countries still on lockdown. Expect currency stability.
The AUD continues to be supported due to outperformance on COVID-19 measures, strong fiscal/monetary response and a rally in equities. Given this, the view is that the AUD will remain supported but gains will be capped. A lot of good news is priced in and there remains much uncertainty. Case in point, the RBA released its quarterly Statement on Monetary Policy overnight. In short, the outlook is bleak. Inflation and unemployment are both projected to remain far from target.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to remain unchanged at 0.25%
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