The week ahead would have been daunting for investors in any event, but the pandemic's new intensification is complicating the picture for businesses, investors, and policymakers. The disease's evolution has been recognized for five or six months as the deus ex machina for our well-being, the economic fortunes, and the necessary policy responses. The downside risks are materializing as new lockdowns are announced in Europe, and the virus is ravaging large parts of the United States.
The dramatic recovery in Q3 followed the collapse in Q2, but the recovery appeared to be slowing even before new outbreaks. The surging virus underscores this and boosts the chances that some may experience a new contraction. The animal spirits have been driven back into hibernation, even if the markets are more orderly in March and April. Volatility is elevated, and asset preferences over the past few months are being called into question.
Not being virologists, perhaps the best way we can add value now is to consider next week's events. The features include meetings by the Reserve Bank of Australia and the Bank of England, both of whom may ease policy. The US, though, is front and center, with the election, the FOMC meeting, and the October employment report.
Reserve Bank of Australia (November 2): Central bank officials have been dovish and have signaled their intention to ease monetary policy, though they are not committed to the timing or instruments. The market is not waiting. The overnight cash rate and three-year yield are targeted at 25 basis points but have been trading near half as much. Although officials continue to eschew a negative rate target, there is scope to lower the target (by 15 bp), and it may target the five-year yield rather than three-year under its current yield-curve control regime. A Reuters survey found expectations for the RBA to boost its bond-buying by as much A$100 bln and extend the maturities to include 5-10 year securities. Even if it does so, the RBA's balance sheet would be around a quarter of GDP and smaller than the other major central bank's QE. Officials may refrain from setting a formal target and keep the bond-buying open-ended.
Bank of England (November 5): There is little doubt that the Bank of England will ease monetary policy. Most of the focus is on increasing Gilt purchases by GBP100 bln and extending the buying into 2021. The spread of the virus and new restrictive measures will slow the recovery, which already appeared to have lost considerable momentum. The Chancellor of the Exchequer has already moved to offer more support, though the new jobs support program is not as generous as the furlough program that just ended. The government's meal discount program and the cut in the VAT (to 5% from 20%, until March) overstate the forces of disinflation. Nevertheless, Governor Bailey will likely affirm that officials are prepared to do more if necessary. Unlike the RBA, the BOE has kept open the possibility of negative interest rates, and the UK curve is negative through five years. Interpolating from the derivatives market, it appears the market sees the possibility of such a move in late Q1 '21 or early Q2. Meanwhile, although progress has been reported in the UK-EU trade talks, no deal is in hand, and another brink is approaching. A disruption is inevitable even with an agreement.
US Election (November 2): Everyone is familiar with the polls that appear to give the Democratic Party the advantage to take the White House and the Senate. From a high level, the first thing to appreciate is that more than half the number of people who voted in 2016 have already voted. This will allow the parties' apparatus to focus on a smaller universe "to get out the vote." What to watch? If there is one state that could be an early tell, it is Florida. It is big and important. No Republican has been elected President since 1924 without carrying the Sunshine State. Florida has early voting. Many voted early, and since they are counted along the way, the projections could be made relatively early on the election night. President Trump may be seeking an untraditional path. Reports suggest his campaign has pulled ad spending in Florida. This could make sense if he enjoyed a solid lead, which he doesn't, or if he was looking to concentrate his resources elsewhere. Since early September, the Trump campaign resources appear more constrained. The President appears to have redeployed his forces to four midwestern states: Pennsylvania, Ohio, Michigan, and Minnesota. What Florida is to the White House, North Carolina may be to the Senate. If the Democrats do not unseat incumbent Tillis, the odds of capturing the Senate diminish. What adds a greater element of uncertainty is the controversy over mail-in votes and how they are counted, leading to post-election controversies and legal action. While that scenario that has dominated many discussions, the polls suggest a decisive victory is possible, and that there is a high bar for the elite and public to support challenges to the integrity of the electoral system.
Federal Reserve (November 5): As sure as the market is that the BOE will expand its Gilt purchases, it is confident that the Federal Reserve will stick to jawboning than take change its policy. Officials cannot be sure the steepening of the yield curve means that it has persuaded investors that its average inflation target will generate stronger price pressures or whether it primarily reflects the backing up of long-term rates under increasing supply pressure. Back in the late-1970s, the Volcker Fed targeted money-supply, which gave a sophisticated cover to do what he wanted to do. That was to tighten monetary policy despite high unemployment. Now the Powell Fed has come up with a sophisticated cover, average inflation target, to do what it wanted to do: Nothing. The financial markets are functioning fine, last week's stock market tumble notwithstanding. Even if the Fed could push long-term rates 25 or 50 bp lower, there is a sense that it would have only minimal impact. Fed officials, like their counterparts in nearly all high-income countries, stress that the recovery needs stronger fiscal efforts. Growth in the third quarter surprised on the upside, but the economy is not out of the woods by any means, and new fiscal stimulus will be forthcoming. Then, perhaps, monetary policy will be able to do something more effectively.
US Employment (November 6): The US lost about 22 mln jobs in March and April. Since then, roughly 11.4 mln people have returned to work through September. The pace of improvement is slowing and is expected to have slowed for the fourth consecutive month in October. The median forecast in the Bloomberg survey is for an increase of 600k jobs. The latest submissions have lowered the median. A loss of government jobs, perhaps partly related to census workers, means that private sector employment is likely to be stronger than the headline. Nevertheless, the slower pace will be evident here as well. The median projection is for the private sector to have gained 680k jobs after 877k in September. The market's response, barring a significant deviation from expectations, maybe tempered by several considerations. First, the other two events, the anticipation of the US election and the FOMC meeting, will have cleared some positioning. Second, it seems to be well understood that the pace seen in Q3 ( ~7.4% quarter-over-quarter) is not going to be repeated. Forecasts for Q4 growth appear to be initially around 0.6%-0.9% (~2.5%-4%). Without new fiscal support, some activity that was anticipated in Q4 has been shifted into Q1 21.