BlueBay AM: Yeezy does it

July 10, 2020

Sentiment in financial markets remained relatively buoyant over the past week, supported by comments from China, endorsing a rally in stocks as being in the national interest. The Shanghai composite rose by 10% between Monday and Wednesday, creating a positive backdrop in what was otherwise a relatively quiet week in global markets.

Although rates of viral infection continue to increase in the US and many emerging markets, there has been a building consensus that the stress on healthcare systems can be contained when masks are utilised and social-distancing measures are generally respected.

Thankfully, death rates remain subdued. Consequently, there is little to dispel optimism that further lockdowns will be avoided.

At the same time, we continue to see additional fiscal easing being enacted. This week saw the UK announce a further GBP30bn of fiscal stimulus, as governments battle to stymie rising unemployment and the drawdown in consumer demand that this would entail.

Return-to-work push

There is no doubt that government measures to support incomes have helped to sustain consumption during the second quarter. Indeed, with travel, childcare and mortgage costs all falling, many households have seen an increase in disposable income since the onset of COVID. However, as parks and beaches remain full of workers enjoying leisure time, there is an understandable drive to get the workforce back to work and so it is likely that income support will be tapered in the months ahead.

We still expect a fiscal package to be agreed by policymakers in Washington before the end of July, in addition to an agreement on the Recovery Fund at the upcoming EU summit in a few weeks’ time. However, it may be important to remember that the reason such extreme easing measures are being taken is a reflection of the dire state that much of the economy remains in.

The ‘W’ risk

In our assessment, it feels that it would be easy to conclude that financial markets are fully discounting a ‘V’ shaped recovery in the economy and we continue believe that this understates the challenging economic circumstances. Significant portions of the economy remain effectively closed and, notwithstanding an initial bounce in data as lockdowns are eased, we are doubtful that there will be much momentum to sustain this, posing the risk of a ‘W’ shaped dip later in the summer.

Indeed, with a number of US states moving from relaxing to tightening lockdown restrictions as cases rise, it may be that we see this in the economic data as soon as the start of next month.

Paradoxically, however, bad economic news could end up supporting financial markets if this leads to speculation with respect to additional stimulus at a time when the inflationary outlook remains very benign.

With liquidity remaining abundant, it still feels that technicals may dominate fundamentals, leading some investors to worryingly voice the opinion that ‘fundamentals don’t matter anymore’. We may yet hear more comments along these lines, in a world where central banks appear set to deliver de-facto yield curve control, with interest rates stuck at (or below) zero for some years to come, but there is also a sense that this feels highly complacent.

Tech boom in troubled times

Consequently, there is currently a mindset that all news is essentially good news for financial assets. Meanwhile, the notion of accelerated Darwinism continues to see investors flock to perceived tech winners, such that the Nasdaq index is now 17% higher than the start of the year, even as much of the broader market remains in negative territory.

Reflecting on this, it may be understandable that most institutional investors are positioned quite cautiously, especially given the elevated levels of uncertainty, challenging fundamentals and stretched valuations.

However, technicals seem to remain ascendant and unless there is a sufficient catalyst to promote a risk-off move in markets, it strikes us that fear may give way to greed in the next few weeks – until such point when the market is over-extended, leading to a deeper correction thereafter.

Time for an EMFX catch-up?

We continue to see core rates as largely rangebound with central banks endorsing a de-facto policy of yield curve control without publicly admitting as much.

In FX markets, the dollar has started to drift weaker thanks to the generic improvement in risk appetite, coupled with the notion that US growth exceptionalism could be coming to an end for the time being.

We see some scope for the euro to move higher and it is possible that emerging markets FX, which has generically underperformed the risk rally since the start of Q2, could play catch-up. However, we are close to the top of the existing range in EURUSD, which has held for the past two years and with short USD something of a consensual trade, we are wary of a retracement in the near term and retain a neutral stance for the time being.

Elsewhere in FX, we retain an underweight stance on the pound due to Brexit concerns, instead focusing on relative value pairs – such as long Norway versus Sweden, or long Mexico versus South Africa.

Looking ahead

We expect US politics to have a bigger influence on markets later in the quarter. For now, it appears that Biden is in a strong position in swing states and is looking a firm favourite in the race for the White House for the time being. Perhaps of more significance would be a possible scenario in which the Democrats score a clean sweep.

As we have often noted, from an economic point of view, what happens in Congress is potentially more important than the identity of the President. However, much can happen in political campaigns and when one considers how much has happened in the past three months with the onset of the coronavirus, it is sobering to reflect how much can change in a short space of time.

Meanwhile, a suggestion that Kanye West might enter the contest generated no shortage of attention. As a former Trump supporter, one wonders whether a Kanye run at POTUS could take votes from Biden among the young and African American communities. There is even a scenario in which Trump could conclude that he does not want to fight in a race which he is destined to lose badly and he even decides to withdraw. It certainly strikes us that it has never been in Trump’s DNA to lay down quietly and so it may be wise to be prepared to be surprised in the months to come.

But in the short term as we move into mid-summer markets, it seems that newsflow may be quieter and volatility dampened. We look to realise gains on any rally, but generally believe that retaining a long stance in those assets the central banks are purchasing continues to hold merit, even if there may be cause for more caution elsewhere. ‘Yeezy does it’ would seem to be the way to invest for now.