Counting of votes cast in the US elections will continue for several days, but it is already clear that there has been no ‘blue wave’ with the Democratic party winning both the Presidency and clear control of both chambers of Congress. For financial markets, this means the prospect of a large reflationary fiscal expansion is receding.
This is important because the crucial conclusion our fixed income team draws from developments over the last six months is that US monetary policy has now largely exhausted its options for providing stimulus to the COVID-hit economy. At this point, the role of US monetary policy is to accommodate fiscal expenditures, by purchasing the required amount of US Treasury bonds to prevent real yields from rising; only fiscal policy can now provide a significant impulse to growth.
In recent months, Congress and President Trump had failed to pass a follow-up stimulus to the USD 2.2tn Cares Act from March. A divided Congress is unlikely to pass a meaningful aid package in the near future.
Jay Powell, the chair of the US Federal Reserve, has repeatedly warned policymakers that with the economy at an inflection point, providing too little support would be far more dangerous than offering excessive help.
The US economy’s bounce-back from the initial coronavirus shutdowns was perhaps faster than expected. However, key indicators, including those for the labour market, have recently showed signs of a slowdown. The rebound remains fragile. Without significant fiscal aid in coming months, it is unclear that the economy can avoid a new downturn heading into 2021. The risk is that the Fed has to shoulder the burden of responding to a downturn in the economy with inadequate tools.
Chair Powell’s appeals for a fiscal deal have a social dimension: he has noted that additional stimulus would be crucial to saving low-income and minority households disproportionately affected by both the virus and the recession. This would prevent the ‘tragic’ risk of exacerbating existing disparities, he said.
Last week was the worst for global equity markets since March (see Exhibit 1), with the sell-off attributed to caution over coronavirus and the US election. Renewed virus-related lockdowns across much of Europe and the hotly fought US presidential contest drove market volatility higher.
The MSCI All Country World index of global equities fell by 1.2%, leaving it down by 5.3% over the week, its steepest weekly sell-off since March. The US S&P 500 closed down by 1.2% to end the week at -5.6%. The tech-heavy Nasdaq Composite was 2.4% lower and down 5.5% for the week despite better than expected quarterly results from some of the sector’s largest companies.
Stocks recovered somewhat at the start of this week, but the prospect of uncertainty over the outcome of the US election is now weighing on investor sentiment.
The number of new COVID-19 cases continues to rise at an alarming pace across Europe. As a result, governments are having to resort to renewed lockdown measures to stem the surge. The prospect of new spikes with a gap of probably at least six months before a vaccine becomes available means the economic recovery from the pandemic is imperilled. For the time being, valuations of risk assets remain underpinned by injections of liquidity by central banks which continue to do “whatever it takes” to minimise disruption.
There has already clear evidence in survey data (notably the purchasing managers’ index) that Europe’s economic recovery was losing momentum before the second wave. Now, with Europe entering a second lockdown – albeit one that (thus far) looks less draconian than the first – it seems likely that economic activity will contract in the fourth quarter.
At last week’s meeting of the European Central Bank’s governing council, no change was announced to the ECB’s stimulus measures. At the subsequent press conference, President Christine Lagarde noted that “the euro-area economic recovery is losing momentum more rapidly than expected.” She insisted that ECB policymakers will agree on a new package of monetary stimulus in December to counter the risk of the resurgent virus derailing Europe’s economic recovery.
The Federal Open Market Committee meets today and tomorrow, but this meeting is likely to be overshadowed by speculation on the outcome of the US election. On Friday, the US government will publish unemployment data, usually one of the most market-sensitive announcement in the global economic calendar and likely this month to emphasise the need for further fiscal stimulus.
In light of the central bank support measures, we continue to have a positive view on prospects for equities over the medium term. Despite risks to the economic recovery, global liquidity remains abundant. Fundamentally, low real interest rates continue to boost valuations and facilitate fiscal expansion. There remains room for rotation from low-yielding bonds or cash into equities.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.
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