It’s been a rough week in financial markets.
The S&P 500 is now down roughly 10% from recent highs set at the beginning of the month (down nearly 3% on the week). European equities have faired even worse, with the Stoxx 600 down about 3.5%. Crude has also struggled, as have the riskier G10 FX currencies; NZD and AUD are down roughly 3% and 4% respectively on the week, whilst NOK and SEK are doing even worse, down 5.5% and 4.5% on the week.
As you might expect, USD has been the bigger winner; DXY is up around 1.7% on the week, having rallied from below the 93.00 mark to above 94.50. JPY is the second best performer, followed by CAD and GBP (both supported by announcements of more fiscal spending). EUR and CHF are lower largely as a function of USD strength.
Why are we risk off?
1) Rising global Covid-19 cases, particularly in Europe;
The second wave is hitting Europe hard. Many major European countries (UK, France, Spain, Netherlands etc.) are experience record rates of infection (this is partly explained by much higher testing, but it nonetheless reveals the spread of the virus is rapidly rising). As a result, localised lockdowns and economic restrictions are gradually being brought back in, leading investors/traders to revise lower their expectations for global growth; the same rising Covid-19 & restrictions trend is also occurring elsewhere across the globe.
The V-shaped recovery narrative is increasingly turning into expectations for a W-shaped recovery (could we see further recession ahead, perhaps in Q4 during the North Hemisphere’s winter?)
2) Growing disappointment in the lack of further stimulus from both fiscal and monetary authorities;
The US Congress has made no progress towards another round of stimulus, with the death of a Supreme Court judge and battle to replace her a new distractions for the Republicans and Democrats to fight about.
The Fed has refused to say that it is heading towards providing markets with more monetary easing (markets want more QE). The ECB also continues to refuse to indicate more easing is on the horizon.
3) Stretched USD short positioning finally being unwound, perhaps in-light of the growing risk that this US election might end up looking a little nasty;
USD shorts were at eight year highs going into the beginning of this week. Undoubtedly, this will not be the case anymore when we get positioning data at the end of this week. Investors seem to be feeling more cautious and have pulled their short-USD positions (meaning they will have to sell other, likely risky, assets). Contributing to this caution is US President Trump upping the stakes ahead of the election and refusing to commit to a peaceful transfer of power (which most see as the defining aspect of democracy).
Covid-19 cases will continue to rise next week. Likely restrictions will too. Markets will need to continue to come to terms with the fact that the recovery since April is at risk of stalling over the winter. This is likely not fully priced in yet, meaning upside for USD and downside for risk assets might well continue next week.
Strong US data for September might not reverse this trend, given that much of the focus of the worsening COvid-19 outbreak is in Europe. Indeed, it may contribute to a stronger USD.
Finally, in terms of central banks; we will need a big dovish shift in tone for risk assets to get back to recent highs and USD back to recent lows. This might come soon, but I doubt it will come as soon as next week.
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