Morning Commentary: Stimulus Hopes Spring Eternal

Foreign Exchange - Morning Commentary
Stimulus Hopes Spring Eternal  
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The “deadline” for a fiscal stimulus package before the election came and went yesterday, but talks will continue, as hopes for a deal this week remain alive. Ultimately, the view remains that stimulus will not be provided before the election. Despite this, markets remain relatively supported, as they view the current speed bump as a delay in the timing when stimulus comes and not the elimination of stimulus hopes.

The importance of fiscal stimulus to the U.S. economy is illustrated by retail sales numbers. The recovery in retail sales is not unique. Using data through August (the latest month available in most countries), we see that the U.S. has fully recovered from the shutdown and actually sits 2.2% higher than in February. Other countries are in a similar situation, with retail sales in the euro area, Canada and Japan all fully recovered also.

In all these countries, there are some common factors driving the retail recovery. These factors include the shift in spending from services to goods and broad income support for the household sector. In most countries, the income support came through job protections, while the U.S. used expanded unemployment benefits that initially came through the March fiscal stimulus package.

It is this relationship between U.S. retail and fiscal stimulus that flags concerns moving forward. The move higher in September retail sales came after a dip in core August sales. This drop-rebound retail sales pattern aligns with the end of the $600/week enhanced unemployment benefit on July 31 and implementation of a $300/week program. The issue is this replacement program has almost run out of money.

Absent a new fiscal stimulus package, retail sales and the greater economy should face growing headwinds. According to the Congressional Budget Office, which comes under attack from Republicans and Democrats but gets high grades from economists, fiscal policy will become a headwind in the fourth quarter absent new measures. This puts the onus for growth onto normal cyclical factors and hopes for a reduction in COVID-19-related constraints. With COVID-19 cases rising, COVID-19 constraints are, at best, a neutral factor but most likely a headwind. This underscores the need for fiscal action.
  • Perceived progress on stimulus talks has helped push U.S. 10-year yields up to their highest level in four months. Many in the markets are expecting that a Biden victory combined with a Democratic sweep of Congress will pave the way for more spending. This expectation has pushed yields higher and steepened the yield curve. Notably, volatility around the election continues to fall, with recent option trades betting against significant moves after the vote.
  • U.K.-EU Brexit talks continue, with only 10 weeks remaining until a new trade agreement needs to be in place. Recent headlines have been mixed as both sides express optimism for a deal but also indicate a willingness to accept a no-deal Brexit. On this last point, the EU has called U.K. Prime Minister Boris Johnson’s bluff to walk away, classifying the comments as mostly for Johnson’s domestic audience. Ultimately, the market’s subdued reaction to rhetoric from both sides reflects the market’s consensus view that there will be a Brexit deal. This can be seen through the current risk premium on a three-month cable option that implies a 70% chance of a deal.
  • Canadian retail sales disappointed market expectations, as they rose only 0.4% against expectations for a 1.1% increase. Conversely, Canadian inflation came in at expectations, with the year-over-year CPI number rising 0.5%.
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