1.The ECB meeting and stricter lockdowns in Europe
Late on Sunday, both Spain and Italy announced sweeping new measures to limit personal freedoms in an attempt to thwart Covid infection rates, which have risen to record levels in recent days. These new measures include strict curfews and limiting travel in and out of the worst impacted areas, including Naples in Italy. The second wave of Covid seems to be impacting the south of Italy more than the North, which was badly hit in the first wave of the virus. This is problematic for the Italian authorities because the south is poorer than the north and has a weaker health service. If Italy wants to contain the virus and stop the south’s health system from becoming overwhelmed, then infection rates will need to be watched closely, and stricter lockdown measures will have to be considered, which could have economic consequences sooner rather than later. The situation is similar in Spain, where the government has issued a nationwide curfew and has been granted fresh emergency powers to enforce stricter lockdowns if necessary. While businesses and schools remain open in both countries for now, the curfews will have a big impact on economic output in the Eurozone and the recovery in Europe’s economy during Q2 and Q3 is likely to slow during the course of Q4 and beyond.
This is the backdrop facing the ECB as they meet on Thursday. No change is expected at this meeting for a few reasons: 1, the ECB may choose to wait until its December meeting to make a change to see how the course of the virus, and its economic damage, plays out. 2, The ECB already has EUR 750 bn in its emergency bond-buying programme, so there is no big rush to extend this programme further. 3, While the bank has the power to extend its cheap loan facility for European business, it may be wise to wait to see how economic activity in Spain, Italy and elsewhere reacts to the new lockdown measures before offering money at rates as low as -1%.
However, we would note that the ECB did hold steady at its last meeting and ECB President Lagarde also failed to talk out firmly about euro strength, which has helped EUR/USD to rise to its highest level for 2.5 years in recent months. Thus, we cannot rule out action at this meeting. But beware, this action does not have to be a new bond buying programme or a tweak to lending rates, instead, it could be a clear signal from the ECB that it remains willing to do “whatever it takes”, in a timely manner, to protect the Eurozone economy from a second wave of covid. This is significant as the ECB will only pledge this if it intends to act in an effective way in the future. Thus, there is the potential for big moves in European asset prices on Thursday. If the ECB goes large on the “we’re here to help, no matter the cost” rhetoric, then this is likely to be bad news for the euro, and the prospect of more liquidity will be good news for stocks in the short term. Some key support levels to watch out for in EUR/USD include: $1.1780 – the 38.2% retracement of the EUR/USD’s uptrend in the past month. $1.1690 is also worth watching in the coming days.
2. US election fear gets real
The S&P 500 experienced its worst week in a month last week, as markets remain under pressure in the lead up to next week’s Presidential election. The polls are predicting a blue wave, a win for the Democrats in the White House and the two houses of Congress, however, the result may not be clear cut, at least not initially. The latest poll of polls conducted by the FT puts Biden ahead with 273 electoral college votes, he needs 270 to win, against a mere 125 for President Trump. Biden is expected to win 51.4% of the popular vote, as the President’s handling of the economy has also failed to impress voters, according to the latest polls. However, the result may not be declared election day. There has been a surge in early voting, and postal voting, due to the Coronavirus restrictions, and this could mean that Trump looks like he has won on the night, but Biden overtakes Trump in the days after the election as all postal votes are counted. Interestingly, all elections in the US are overseen by each state independently, some states like Florida count ballots as they receive them, although the total count is not revealed until polling closes on election night. Other states such as Michigan only count absentee ballots on election night. Some states allow absentee ballots to be postmarked on election day, but they may not be counted until several days later. This means that the only way there will be a clear winner on election night is if Biden wins by a landslide, which would be an even bigger margin than he is currently expected to win. The more likely scenario would be no clear result for days, or even weeks, after the election. If it comes down to a Supreme Court decision, like it did between Bush and Gore in 2000, we could see a much messier process than we did 20 years ago because the US Senate moved forward with a final confirmation vote for President Trump’s Supreme Court nominee Amy Coney Barrett, which makes it likely that an ultra-conservative Republican will be joining the Supreme Court in the coming days. The market impact of this is worth noting: a “blue wave” and a big win for the Democrats is likely to trigger a major rally in US and global risk assets as the markets price in a speedy multi-trillion-dollar fiscal stimulus package for the US economy. A less stellar win for Biden and a divided Congress would temper that rally, in our view. While a highly contested election, with no winner declared for days and weeks, and potentially an incumbent President unwilling to accept a result that is unfavourable for him, would be deeply unsettling, and could lead to a rally in safe havens and a deep sell off in risky assets in the days and weeks after the election. Due to the possibility of this latter scenario, we could see some buying of safe havens in the coming days as we lead up to the US Presidential election.
Further uncertainty around the election result could also be fuelled by US economic data due out this week, the most important of which is the US GDP reading for Q3 that is scheduled for release on Thursday. The economy is expected to expand by 30.8%, which would reverse the bulk of the 31.4% decline in Q2. A strong bounce back in US economic growth may help boost President Trump’s fledging campaign in the final days before the election.
3. What next for the UK?
It is worth remembering that a big win for Biden could be unsettling for the UK government. Already there is supposedly some concern in Downing Street that if Biden does become President he could delay or block a post Brexit trade deal between the US and the UK. Thus, a win for Biden could trigger a selloff in the pound. GBP/USD is above $1.30 as we start a new week and has been trading in a $1.27- $1.34 range since the start of September, which highlights how jittery the market is where sterling is concerned. Thus, not only is the UK sensitive to its own growing coronavirus crisis and its never-ending trade negotiations with the EU, but now Joe Biden is a risk for GBP. We believe that this trifecta of risk is enough to cause a mild downturn in GBP this week, with $1.2890, the low from mid-October, a key support level.
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