After yesterday’s selloff, the U.S. dollar has come down from its highs and equity markets have stabilized off their lows. Despite rising infection rates, concerns around a new COVID-19 strain and Brexit worries, markets remain constructive.
As we round the bend on 2020 and head toward 2021, this constructive narrative that has characterized markets over recent months should extend into the new year. Declining trade and geopolitical uncertainty and expectations for a successful vaccination campaign and a global recovery in 2021 have given markets cover to look through near-term uncertainties. While there is justification for this constructive outlook, a few risk events, lower liquidity and year-end dynamics over the next three weeks could bring increased volatility and a pullback in sentiment.
The first risk factor is the continuing Northern Hemisphere winter COVID-19 surge, with restrictions increasing in developed and emerging markets. Thus far, asset prices have shown little performance differentiation based on the intensity of the virus’s spread. This is likely due to the belief that activity restrictions will remain targeted, with vaccine development lowering the chances of another wave. However, activity data and growth forecasts in countries hit by the virus have taken a hit.
The second issue is the end of the U.K.–EU transition period on Dec. 31. A Brexit deal remains the market’s base case, but this is far from a certainty. Case in point, the pound traded up sharply during yesterday’s session after the U.K. made a concession in fishing rights but has since given up all those gains and more, as the EU remains unmoved. Regardless of the outcome, expect higher volatility around year-end.
There is also the U.S. Senate runoff in Georgia on Jan. 5. Markets are assuming a split Congress, which will keep more progressive initiatives in check. This assumption is informed by polls that favor Republicans keeping control of the Senate, but the runoff elections are far from a done deal. Should the Democrats deliver a surprise victory, expect a spike higher in volatility, as it would, in theory, open the door to higher taxes, more public spending and possible changes to Senate rules. U.S. yields could also move higher on expectations for more fiscal spending. This move higher in yields would likely hit risky assets, including emerging market currencies.
On a broader level, the global recovery narrative depends on the success of the vaccination program. Issues regarding production, distribution, adoption and efficacy of the vaccines should lead to negative reactions. As seen this week, a similar reaction is expected around mutations and new strains of the virus, although hope remains that the current vaccines are effective against these new strains.
Finally, once we move past the pandemic, expect idiosyncratic risks to become more relevant. While there is an expectation that the U.S.–China relationship will take on a more diplomatic approach, geopolitical tensions can still arise as the new U.S. administration is tested and as the contentious relationship continues. There are also elections in key European countries that could bring surprise results, and challenges remain in emerging markets. And of course, there are the “unknown unknowns” that can upend everything. Just ask 2020. | |
| HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT: | |
- Congress finally passed a spending bill last night. President Trump now has until Dec. 28 to sign the $1.4 trillion bill. Attached to this bill is roughly $900 billion in COVID-19 related aid. The bill was so long that lawmakers had to pass a temporary funding measure to allow enough time to prepare all 5,593 pages. While the passage of this relief package is welcome, discussions around the need for more stimulus have already begun.
- Nearly 1.5 million voters have already cast ballots in Georgia’s Senate runoff election, signaling a competitive race that should break state voting records.
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