The International Monetary Fund (IMF) meetings over the next two weeks, and especially the main events starting the week after next, are set to dominate financial market headlines. Due to the COVID-19 pandemic, the meetings will be virtual and allow more participants than usual. Given that 2020 has turned out to be the most challenging year since the 2008 global financial crisis, expect markets to pay close attention to comments on fiscal and monetary policy.
September’s market selloff was a reality check to a market that was complacent to the realities of the recovery. The reality remains that re-openings would lead to increased COVID-19 infections and that has happened. Countries are now forced to re-introduce containment measures which will, by definition, be a headwind to an economic recovery. However, it should be noted that the market’s correction has been relatively small when compared to the equity market rally since March.
The IMF meetings will give market participants the opportunity to assess the state of global economic conditions against a backdrop of elevated uncertainty and multiple sources of impending risks. Comments out of the IMF meetings are also important in a general sense because these meetings tend to lead to consensus that moves markets, at least in the short term.
The expectation is for IMF to take a bearish tone. The IMF is likely to acknowledge that the Q3 recovery was faster than expected but cite temporary base effects as a distortion to strong growth numbers. Further, expect the IMF to warn that the economic path forward is weak, use this as a platform to call for more decisive macro policy action where there is room and keep policies accommodative for as long as it takes. However, the IMF is also likely to acknowledge the risk of unsustainable policies and policy constraints in some countries.
Overall, the IMF’s message is likely to be that the global pandemic is a real economic shock that is persisting and will need policy support through all necessary means. Authorities, especially central bank speakers, are expected to be reassuring as talk is free, but in practice, policy challenges remain with historically high debt levels and rates already close to zero, if not already negative.
The USD has found support stemming from concerns about rising COVID cases in Europe that should lead to new restrictions and increased US political uncertainty. These factors resulted in EURUSD moving down to levels not seen since July, but the single currency has since recovered some of those losses. Given the euro’s pullback, the risk/reward trade off supports being long, but elevated uncertainty that supports the USD puts into question the euro’s ability for meaningful near term gains. With the EU recovery fund priced in, further outperformance will need to come from economic outperformance, but this is made difficult due to the rise in COVID cases and leaves the euro vulnerable.
The pound should continue to be driven by Brexit headlines and broader risk sentiment. This past week was a mix of GBP strength and weakness driven by headlines expressing optimism and pessimism on Brexit. As an example, the GBP weakened on headlines that the UK-EU failed to close their differences on state aid and that the EU was prepared to take legal action. Shortly after, this was replaced by headlines indicating that a “landing zone on state aid has been identified” which strengthened the GBP only for EU officials to state that there was no increased optimism in Brexit talks. Expect this whipsawing to continue as we get closer to the mid-October EU summit. The more that the EU summit is seen as a stringent deadline, the more the GBP will trade in a binary fashion. For now, optimism over a relatively positive UK-EU negotiating result is in the market and should support the GBP, but uncertainty remains high leaving downside risk greater than upside potential.
Broader risk sentiment and the USD should be the key drivers for USDJPY this coming week. On the political front, the newly formed cabinet and Suganomics looks a lot like Abenomics. Japan’s Tankan survey was last week’s key economic release and came in below expectations. Overall, fading domestic political uncertainty, fewer COVID-19 cases in Japan and a reduction in outbound flows relative to earlier in the year should support JPY appreciation.
PM Trudeau recently gave a speech indicating the need for more fiscal support. His plan includes measures for unemployment, programs to boost job growth and funding for testing, and measures to fight climate change. Notably, government yields were relatively unchanged after these comments and the markets remain unconcerned about Canada’s fiscal credibility. Near term drivers are expected to be the global risk backdrop, oil prices and the USD. That said, there does not appear to be an overarching rationale for being either long or short as CAD positioning is neutral and the Fed/BoC are inactive.
Headlines around US-China tensions continue to come out, but ultimately, the markets are viewing the recent actions and rhetoric from both sides as largely symbolic. A strong balance of payment position and the market consensus for USD weakness form the base for a stronger CNY. Capital inflows, especially on the bond side, have been strong and are expected to be persistent as the global search for yield continues. Longer term, geopolitics remain a concern especially as we get closer to the US election, but for now, expect the yuan to be supported.
Price action appears to suggest that markets are starting to become comfortable with a Biden victory and the possibility of a Democratic sweep. Should this happen, the Chinese yuan and other Asian currencies should benefit and pull the AUD higher along the way. The RBA meets next week and is expected to keep rates unchanged. Further AUD consolidation appears in the cards, but risks are for further losses after recent dovish hints from the RBA including Deputy Governor Debelle outlining possible options for further easing.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to remain unchanged at 0.25%
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