Is it safe to get back in the water? The Chinese seem to think so, while the Western world turns its attention to elections & vacations in the face of low-key summer markets.
The past week has seen a continuation of relatively calm market conditions, with assets largely trading in a sideways direction.
In the US, some signs of progress on fiscal talks have supported sentiment, though the delay in announcing additional measures may well start to weight on economic data in August. Following several months in which economic activity has rebounded sharply, there are now more signs in high-frequency labour market and consumer-spending data that this improvement has levelled off in the past few weeks.
US Federal Reserve minutes contained little new information and US/China talks have been suspended, yet we see low risks to the Phase 1 trade deal, even if some anti-China rhetoric seems likely to ramp-up into the forthcoming election campaign.
In Europe, rising Covid-19 numbers have seen increased restrictions on mobility, while France has moved to mandate the wearing of masks in all workplaces. Such measures may limit policymakers’ attempts to try to return employees to the workplace and normalise economic activity.
More generally speaking, we see scope for further economic divergence between Northern and Southern Europe and it will be important to discern whether economic stress leads to increased political volatility in the months ahead.
On the topic of politics
Events in Washington are likely to dominate investor thinking for the next couple of months. This week saw the (virtual) Democratic Convention with Joe Biden and Kamala Harris formally accepting their party nominations.
For now, the Democrats continue to enjoy a healthy lead over the Republicans, but in recent days there is a sense that this lead could be narrowing – particularly in the race for the Senate.
Consequently, the odds on a ‘blue wave’, with the Democrats getting the clean sweep with respect to the President, Senate and the House, appear to have lengthened. This remains the base case assessment for the time being, however, a lot can happen in a couple of months and there is a fear in Democrat circles that Biden could bleed support every time he opens his mouth.
Meanwhile, Republican strategists appear to have concluded that there is little they can do to enhance Trump’s 40% approval rating and therefore are seeking to attack Biden, hoping to drag his ratings to a similarly low level.
A tacit desire to limit voter turnout, by making postal voting more difficult to expedite and by allowing lengthy wait times at polling stations to discourage non-politically engaged voters, may also be tactics which could yet play into Trump’s hands on election day. Arguably, it was low turnout in some swing states that saw Hilary fail in her bid for the White House.
This time around it may seem that US voters are once again asked to choose between two candidates they have little love for. The election is not having too much of a bearing on financial markets for the time being. However, this may well change as we move into the fall and the political temperature rises.
From bad to worse
If US politics may appear something of a spectacle, in the UK it seems as if we are living through more of a farce – with the U-turn over student exam results the latest in a set of blunders from a government which seems to stumble from one shambles to the next.
With Brexit negotiations re-starting, it is hoped that the government may be able to agree a ‘skinny deal’ with the EU at the very least in the weeks ahead. Yet, faced with the reality of Brexit looming, it seems as if there are still many things to resolve and find a compromise on. Thus far, the mantra of the Johnson government seems to be that if something can go wrong, it will go wrong.
We believe that a deal should get done in September, but even this may prove a short-lived victory. From this point of view, we maintain a relatively downbeat assessment on the pound and UK assets.
Meanwhile, a robust UK inflation print this week also served as a reminder of the UK’s tendency to create more inflation than its G7 peers. This will be temporarily reversed next month, due to the cost of restaurant food being slashed, as a result of August’s ‘Eat Out to Help Out’ scheme, which risks being a victim of its own success.
Rising unemployment is also likely to dampen inflationary pressure, yet should the trajectory turn more favourable next year, we could certainly see scope for long-dated UK yields to rise more than other markets over the medium to long term.
Summer lull for markets
Corporate credit markets have been quiet over the past month with limited new supply seeing spreads grind tighter. The exception to this rule has been the US high yield market, which has seen a surprisingly elevated level of activity during the month, with some deals which had been slated for September being brought forward to take advantage of relatively benign market conditions, which have seen US stocks register record highs.
Index spreads in US high yield are now slightly wider on a month-to-date basis as a result of new issuance re-pricing existing paper, yet the CDX High Yield Index has tightened during the same period, demonstrating the significant role which technicals can have on spread movements.
Bearing this in mind, we continue to run low levels of credit risk for the time being, having realized gains on many positions pending forthcoming supply in investment-grade markets in September. Although this supply is likely to be at much more modest levels than we saw earlier in the year, we still expect there to be opportunities to add risk next month and are happy to bide our time for now. Heavy supply is also likely to be a feature in sovereign credit and here we are also inclined to reduce remaining exposure.
FX markets have been an area of investor interest during the past month with the dollar trending weaker. The greenback recorded a new low versus the euro during the past week, yet there may be a sense that this trend has lost much of its earlier momentum. In emerging markets, EMFX has underperformed in the weak dollar move, underlining some of the fundamental challenges faced by the asset class in the absence of material newflows into local currency fixed income and equities year-to-date.
During the past week, the Russian ruble has been under some pressure as political tensions in Belarus come to a head. Developments in Minsk create the risk of Russian intervention, which could lead to further international sanctions and possible capital flight.
Elsewhere, this week’s political upheaval in Romania is also creating the risk of credit downgrades if moves to cut pension increases are subsequently reversed. Broadly speaking, it is interesting to observe how the coronavirus shock is leading policymakers in different countries to pursue different courses of action as they seek to mitigate the fallout on their populations.
Perhaps it would not be too surprising if next week follows the relatively quiet and benign pattern of the month thus far. We have a (virtual) Jackson Hole discussion on monetary policy affairs coming up at the end of August and investors are waiting for announcements with respect to a review that the Fed is conducting regarding its monetary policy framework. However, this should deliver relatively few surprises, since we have already heard how the Fed may seek to manage policy ‘behind the curve’ in a forthcoming monetary cycle in order to allow inflation to overshoot a little to make up for past undershooting of prices.
Otherwise, US focus is likely to centre on ongoing fiscal discussions, where a compromise deal for around USD1.5 trillion remains probable before Labor Day. In Europe, most still remain away on holiday (or would be, if they were in a position to travel to the beach destinations they would like to be holidaying in).
There is a sense of waiting for markets to come back to life at the start of September. Meanwhile, it seems that the whole focus on Covid-19 itself is now starting to fade into the background. Despite daily data on infection numbers, there is now a sense that we have become used to living with this. At the same time, mortality rates continue to drop, as treatments become more effective and the virus shows signs of mutating into a less deadly form. Healthcare systems are far from overwhelmed and in many countries, hospitals are sitting eerily quiet.
Increasingly, it seems that the fear of the virus is now killing more than the reality of the virus itself. Some may say that we are in the eye of the storm and the second wave will build, yet the curve has flattened in the US and it seems that any return to a more rigidly enforced lockdown will only be applied to local hotspots, rather than at a national level, on a forward-looking basis.
Pictures from a Wuhan pool party this week gave a stark reminder of how life can return to normal. One has to smile at the realisation that we can now feel a twinge of envy towards a place which we felt only pity for just a few months ago. It is a blunt reminder of how things can change in a relatively short period of time.
It will be a happy day when the term ‘social distancing’ is consigned to the dustbin, though at the same time, that line about ‘people being most at risk just when they think it is safe to get back into the water’ still seems to call out. Perhaps I shouldn’t have watched so many Jaws movies with the kids on lockdown.