BlueBay AM: Beware the Trumpkin

BlueBay AM: Beware the Trumpkin

23 oktober 2020

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By Mark Dowding, CIO at BlueBay Asset Management

Markets face a few potential scares ahead; hopefully the election won’t end in a fright.

Risk appetite has remained relatively well supported over the past week, notwithstanding climbing rates of Covid infection and an inconclusive outcome with respect to ongoing talks relating to US fiscal stimulus.
In our eyes, it seems that a budget deal is unlikely before the election. Yet it appears that, unless there is a more rapid deterioration in economic data, then markets may remain content to look further ahead to prospects of fiscal easing under a new administration at the start of next year.
 
For now, US data has been relatively upbeat. Business and consumer confidence has been edging higher, housing market activity has been firming and retail sales have also held-up well. Some high-frequency data are highlighting softness in October, but it still seems that the recovery remains intact.
 
Worrying winter shift
 
Thus far, it appears that countries across Europe have witnessed a more substantial second Covid wave, leading to greater curtailment of economic activity as lockdown measures are re-imposed. 
 
By contrast, in the US, daily aircraft passenger numbers rose above the one-million mark for the first time since March during the past week. However, warm autumn weather may have been beneficial to the US in this respect, but it is now getting colder across the northern hemisphere. Worryingly, it seems that there is a trend toward acceleration on both sides of the Atlantic, emphasising the need for progress with respect to vaccine approval relatively soon before more draconian measures need to be taken.
 
Election scenarios
 
With 11 days left to go until the US goes to the polls, there has been some suggestion that Trump is narrowing the gap to Biden in several key swing states. Markets remain pretty convinced of a ‘blue wave’ scenario and it seems right to have this as a base case, but there are a number of different permutations which may be possible. 
 
A win for Trump would come as a surprise, but we doubt markets would react too much to this. Conversely, a contested outcome with no clear winner more than 48 hours after the polls close could represent a more challenging scenario. Negative sentiment could also follow in the wake of a collapse in Republican support, such that the Democrats have a commanding majority in the Senate, leading to worries that the filibuster would be overturned and that progressive Democrats could seek to implement a platform of significant and wide-ranging change. 
 
Other scenarios may see markets firm with uncertainty out of the way and investors looking forward to sunny uplands of further policy easing and firming economic growth in 2021, with the Fed anchoring rates for a considerable period in the absence of inflationary pressures.
 
Asset purchases to remain
 
In Europe, next week’s ECB meeting is expected to lay the ground for further policy easing in December. It is possible that the ECB will lower interest rates by another 10 basis points, but it is hard to see this achieving a great deal. 
 
For the foreseeable future, we believe that asset purchases will remain the main source of policy easing and with government deficits being revised upwards, this will enable the central bank to provide de-facto monetary financing of deficits – even if this is something explicitly banned under the ECB’s own charter. 
 
For the time being, we doubt that countries in Northern Europe will want or be able to push back on the argument for further central bank balance-sheet expansion, but this could remain a source of sensitivity heading into 2021. 
 
Against this backdrop, sovereign and investment-grade credit spreads may be well supported in the EU, meaning that even bad news (on the virus) is seen in a constructive light with respect to fixed income markets in the region.
 
Brexit deadlines come and go…
 
Meanwhile, in the UK, ongoing Brexit discussions remain a focus of investor attention. The UK government’s mid-October deadline has come and gone and it appears that the next deadline has been set for the middle of November. 
 
Were talks to fail, this would leave even less time for individuals and businesses to prepare for a ‘no deal’ exit, which could see a run on basic foods and medicine in a country suffering in the middle of a global pandemic. In this context, we remain confident that pragmatism will win the day and that a compromise will be found, even if this now seems set to drag on into November.
 
Sterling has firmed a little on hopes that talks are moving the right way. Elsewhere, FX markets have witnessed a degree of dollar weakness over the past couple weeks. The Chinese renminbi has been making solid ground versus the greenback, thanks to robust economic performance. Emerging market currencies have been assisted by constructive risk appetite over the past few weeks.
 
Looking ahead
 
It appears that there is still plenty of uncertainty in the macro landscape. The US election, budget talks, Brexit negotiations and vaccine approval could all lead to a material improvement or deterioration in market sentiment over the next couple of weeks and it is understandable that investors may want to proceed with caution for the time being, given the scope for volatility. However, retaining a moderately constructive bias appears to be warranted as we look beyond these events and continue to look at the scope for further policy accommodation.
 
It seems that financial repression remains set to drive money towards more risk-seeking assets and we continue to expect core government bond yields to be largely anchored by the actions of central banks.
 
There may be bumps in the road ahead and it seems prudent to invest with a degree of caution, leaving scope to add risk into any future dips. Halloween is coming and there may be a few scares, yet, when the US election is done, we just hope that the Trumpkin can behave himself.

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