“Commencing countdown, engines on…”
- David Bowie, Space Oddity
Through much of 2020, the macroeconomic backdrop, financial markets and, in some respects, life in general has been dominated by a number of uncertainties. To varying degrees, the pandemic spread of a previously unknown virus, the intense focus on the US Presidential election, the ultimate ‘end-game’ for Brexit as well as the context and impact of acute fiscal and monetary activism across the world have driven this perpetual dominance of uncertainty. However, as we reach the culmination (or what we currently expect is the culmination), or final countdown of the 2020 US Presidential election, we are inclined to turn our attentions to the themes that we feel will evolve from uncertainties to the themes that we feel will shape the financial markets as we move towards and into 2021.
While a definitive result in the US presidential race remains elusive, it could certainly be argued that the inability of the US to decide between the two candidates is a rejection of both - the character of one, and the ideology of the other - and a clear indication that the pollsters were in no small part either oblivious to or complicit in their own political bias distorting expectations. However, as the counting continues (potentially for a significantly extended period), markets have remained calm. This is highly related to the fact that such an inconclusive result (what increasingly looks like a Biden Presidency, but with a Republican Senate) likely brings a more dovish, inclusive, multilateral approach to foreign policy and international trade, while at the same time preventing domestically hawkish tax and regulatory change. This combination is likely sweetened further by the high likelihood of a fiscal stimulus – albeit smaller and more delayed than it may otherwise have been – in short, providing a positive backdrop for US economic and ultimately risk asset price growth.
Over recent weeks, commentators and analysts have been prolific in their issuance of linear prescriptions for what to do with generic asset classes in the event of ‘checkbox’ outcomes. We are inclined to see things as both more complicated and simpler than that. It is not clear that there is a generic formula for different asset classes under the now probable (but unexpected) election outcome. For example, from a foreign exchange perspective, it is not singularly a case of USD up or down, but up or down against what? At the same time, we are of the opinion that there are some USD crosses that make intuitive sense from here.
In the DM space, we continue to view the potential for exacerbated growth and inflation differentials as being the dominant factor for EURUSD going forward and the (likely) risk positive election outcome should further enhance the potential for US growth outperformance. However, we are also comfortable with the views that both AUD and GBP can make ground against the USD: AUD, as a function of impressive and intensifying growth in China, as well as the boost from this week’s rate (and yield curve target) cut and new QE programme; and GBP, as a function of the dissipation of its own uncertainties, as Brexit reaches its own end-game (perhaps quicker, and more resolutely, than the market currently anticipates).
In the EM space, we also think that the (likely) combination of a less confrontational foreign policy and more cooperative trade policy is a positive in general. However, ‘some EM’s are more equal than others’ in reality, and while we believe that high yield MXN should be a natural beneficiary of potentially improved relations and more clearly improved US growth prospects (we would also argue strongly that this applies to CNY), it is not clear to us that this view is as compelling across EM generically.
Interestingly, yesterday morning I heard the argument that, given the election outcome (if confirmed), then EM currency volatility trades rich to the DM equivalent. We would agree with this sentiment, however, we would once more contest the protagonists’ conclusions. Instead of the more complex suggestion of selling EM volatility relative to DM volatility, we would argue that a lower volatility than implied by the market is an argument to own the EM FX, particularly in the idiosyncratic scenarios that we outline above, where there is also a significant positive carry.
We would argue that the engines of US growth were already on, and indeed that this growth accelerated in October. The countdown to the conclusion of the US elections, and the removal of an area of acute uncertainty, likely clears the skies above. Engines on...
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