Macro Strategy: USD bottomed? US elections and Asian credit
FX Daily: USD is holding up better-than-expected
USD mounted an unusual rally with Wall Street on Thursday. On most days, the greenback would have depreciated on an improvement in risk appetite. Thursday’s rally in Wall Street was, however, more about America’s relatively stronger fundamentals. Advance US GDP estimate came in stronger at an annualized 33.1% qoq sa in 3Q vs the consensus for a rebound to 32.0% from -31.4%. Initial jobless claims fell to a 751k for week ended 17 October, the lowest since the week of 14 March. Another slide in nonfarm payrolls is expected next Friday after the US elections.
Against this background, we question the market’s expectations for the USD to depreciate on a Blue Sweep at the US elections on 3 November. Moody’s Analytics reckoned that the US economy and labour market would perform better under a Biden presidency compared to a second term under Trump. Unlike a month ago, the EU economic outlook has also darkened dramatically from the coronavirus resurgence and new locksdowns. We noted that the VIX volatility index has stayed lofty despite higher equities, wary of the misinformation, conspiracy theories and debates over other outcomes such as a Red Wave, a Senate still held by the Republicans, and the nightmare scenario of a contested presidency.
Divergences have also emerged on monetary policy, not just the economy in favour of the USD. The Fed is on hold and prefers more fiscal stimulus to support the recovery. Central banks in the Eurozone, UK and Australia have signalled more monetary stimulus in November-December. We have noted that the USD has recently drawn support from its wider bond yield differentials against these currencies. The USD (Index) needs to break above 94 to extend its recovery.
EUR is weighed by its weakened fundamentals; our end-year target remains at 1.15. EURUSD fell to around 1.1650 where its 100-day moving average is located. European stocks, as measured by the Euro Stoxx 50, was flat to weaker by 0.1%. Double-dip worries have emerged now that France and Germany have gone into lockdowns on the second wave of infections overwhelming the Eurozone. The European Central Bank signalled, at its governing council yesterday, that risks were clearly on the downside with a promise to recalibrate its instruments by its next meeting in December. Today’s data releases are expected to see, for a third straight month, an unemployment rate above 8% in September amidst negative CPI inflation in October. Not surprisingly, the EUR is increasingly weighed by the deeper negative 10Y EU-US bond yield differential.
GBP is heavy on Brexit risks and domestic political uncertainties. GBPUSD fell for a second session and extended its fall below 1.30 to 1.2930. First, the risk of a no-deal Brexit cannot be ruled out by the end of the transition period on 31 December. EU and UK have not been able to overcome the impasse over fisheries and the level playing for a trade deal. Second, US presidential candidate Joe Biden, who is expected to win next week’s US elections, has warned that a US-UK trade deal would not happen. The Internal Market Bill has undermined the Northern Ireland peace process which has been viewed as a success of American foreign policy. The House of Lords is, however, scheduled to vote, on 9 November, against the controversial clauses in the bill. Third, Prime Minister is under pressure from Tory rebels and government medical advisers over his handling of the coronavirus. Fourth, the Bank of England is expected to increase the size of its asset purchases for a third time at its next meeting on 5 November. The negative 10Y UK-US bond yield differential has deepened to -60 bps, its widest since March. GBPUSD should remain in a 1.25-1.30 range with a downside bias.
AUD has a neutral-to-bearish momentum near the floor of of its month-long 0.70-0.72 range. Consensus has pencilled in a rate cut at the next Reserve Bank of Australia monetary policy meeting on 3 November. The targets for the cash rate and the 3Y bond yield are likely to fall to new record lows of 0.10% from 0.25%. The RBA is keen to dispel the notion that it has run out of firepower. Apart from more bond purchases, the RBA could also target longer-dated bond yields. These policy moves could tilt the favour towards the USD from the AUD if it succeeds in cementing the recent push by the 10Y AU-US bond differential to turn negative. Failure to hold 0.70 could lead AUDUSD down towards 0.68.
Credit: US election scenarios for Asian credit
US elections are finally due next week, with the result set to influence both prospects of US fiscal stimulus, and the future of US-China trade relations. Market expectations have coalesced around a Biden presidency, with some hope of even a blue sweep of both House and Senate. Another possibility, though much slimmer, is a Republican sweep. Both eventualities entail a sizeable fiscal stimulus that will deliver a boost to US growth. A strong reflationary environment should stoke appetite for Asian credit, particularly those of export-oriented economies. This could parallel the 2017 experience, as expectations of stimulus from Trump’s tax cuts drove a 17bps compression in spreads for our Asian DACS index to record lows.
Another likely scenario is that of a Biden Presidency and a Republican Senate. This may temper expectations of a sizeable fiscal policy lift, with bipartisan divisions being as large as they are. Focus could return to US COVID-19 cases, as Europe reintroduces lockdowns to tackle a second wave. That said, sentiment may still improve over time, if markets sense a more effective approach to controlling the pandemic under Biden. A gradual compression in Asian spreads could follow, helped by dissipating political risks. The major tail risk for this election is that of a contested outcome, which could engender civil unrest, fiscal deadlock or provocative geopolitical actions. Credit volatility may jump initially, but we expect any large market upheavals to prove transitory given ample USD liquidity and credit backstops provided by the Fed.
Beyond fiscal policy, Biden’s stance on China, including his approach to trade and human rights issues, remains a critical unknown to watch. A US return to multilateralism, and a negotiated reduction in tariffs, will be most welcomed by Asian credit markets. On the other hand, continuation of a China containment strategy, with pressures on both trade and tech, could lead to renewed tensions that drive a widening in Asian spreads.
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