In this edition of the Daily Briefing we focus on the impact of the US presidential election and the outbreak of coronavirus on global markets. Veda Partners outlines why it believes Joe Biden is likely to win in this year’s poll and engage in a large round of fiscal spending 2021, while Deutsche Bank highlights a surge in support for Bernie Sanders, which appears to be improving the chances of a Trump victory. It is coronavirus, however, that is the main focus for investors. Pantheon Macroeconomics lays out the policy options open to the Chinese authorities in the wake of the outbreak, while Trend Macro questions the limited impact on markets outside China and whether this is likely to continue. Finally, Macro Risk Advisors provide insight on how the options market is viewing risk amid the growing uncertainty.
Substantive's Top Themes - Best of the Broker Notes
1. What the option market tells us about markets
Macro Risk Advisors put out their latest risk report over the weekend assessing the option markets across the asset classes, which produces some useful insights on where markets are at currently, and well worth keeping an eye on, they say. Holistically, MRA say markets are in an environment of low economic data variability but increasingly higher policy uncertainty. Among other interesting observations, they provide one compelling chart that shows the disconnect (quickly coming undone?) between flagging PMI and credit spreads, while another shows the increasing tendency for the SPX to lurch from quiet to chaos. They also note the attractive correlation characteristics of gold. On election risk, they show how US election uncertainty is being priced into long dated VIX futures. Finally there are a couple of other observations from the report that caught the eye. MRA highlight the MOVE index which, along with the yield curve, is suggesting more action than Fed statements convey, while on the equity front, 5-day realized SPX volatility has approached 20, where last week we saw 2 down moves worse than 1.5% in the SPX, something we haven’t experienced since Dec’18.
2. Is coronavirus a Chinese bio-weapon?
Considering that coronavirus outbreak invokes memories of the 1918 “Spanish flu” pandemic, in which a third of the world’s population was infected and as much as 5% of the world’s population died – and comes after a big bull run in equities – it’s amazing that the risk-off reaction has been so little other than in Chinese equities, according to the latest note from Trend Macro’s Don Luskin. The S&P 500, at the time of Luskin’s writing, was off 3.69% from recent all-time highs, and down less than half a percent since coronavirus came into the headlines, he notes. Luskin says his instinct is to expect at least as much of a risk-off correction as witnessed in 2003 with SARS – a 6% drop in the S&P 500 – or in 2014 with Ebola – 10%. That said, he says the market is already seeing the signs of “panicky crazy-talk” that usually points to a bottom, with reports swirling that the coronavirus is a Chinese bio-weapon gone wrong. Even though it’s likely to be just a bogus conspiracy theory, Luskin reckons the plausibility of the idea speaks volumes about China’s present economic and geopolitical dilemma – it is increasingly being seen, both internally and externally, as too aggressive, too authoritarian and not quite competent. If global companies weren’t already concerned by their concentrated supply chain vulnerability in China, they are now.
3. Early PBoC cut confirms official worry over virus fallout
Pantheon Macro has put out a note outlining the options open to the Chinese authorities as it looks to mitigate the effects of the coronavirus outbreak on markets and its economy. The PBoC has cut its 7-day and 14-day reverse repo rate and injected Rmb1.2 trillion through open market operations, the largest injection ever, says the firm. Pantheon Macroeconomics notes, however, that authorities are using short-term instruments, rather than the lending facilities or a reserve ration cut, suggesting that they continue to hope for a swift resolution, and remain unwilling to jeopardise longer-term plans with a slosh of interbank liquidity. The firm thinks these measures are coming, however, and although the exact timing may be tricky, it expects a series of interest rate cuts, and an RRR cut, in reasonably quick succession. In addition, says Pantheon Macroeconomics, the authorities are likely to revise down their 2020 GDP growth forecasts, and raise deficit targets. The firm’s Chief Asia Economist, Freya Beamish will be hosting a Webinar on Thursday, the topic: ‘’Containing the Coronavirus is Costing China it’s Recovery.’’
4. Investor inquiries from the road
Veda Partner’s Henrietta Treyz is spearheading a rolling conference with key campaign and policy staff throughout the year to discuss the US election and the policy outcomes that may result from another Trump administration or a Democratic administration in 2021. The firm has issued a note highlighting some of the recurring questions it has received from investors over the last week. First, Veda says there will not be a further economic stimulus in the US in 2020, either in the form of tax cuts or spending increases. As for the Democratic nomination, the firm believes Joe Biden is the most likely candidate to emerge victorious, and that he will go on to win the general election. Veda monitors relevant polls and regularly publishes an ‘odds tracker’ on a variety of topics. Among Democratic contenders, Veda says only Biden has a realistic chance of carrying both the House of Representatives and the Senate, which has significant implications for federal spending and tax changes under his leadership. Indeed, the firm says given Biden’s history as a bipartisan vote-getter, it expects his first priority will be spending federal dollars.
5. What is the market to make of the Sanders surge?
Deutsche Bank’s Alan Ruskin focuses on the surge in support for Bernie Sanders in the Democratic primaries and points to data provided by PredectIt that appears to support the school of thought that the higher the probability of Sanders becoming the democrat Presidential candidate, the higher the probability of a Trump re-election. The bank says the data shows a 10% increase in the probability of Sanders being the candidate has been associated with approximately a 2% increase in the implied probability of Trump being re-elected. As Deutsche Bank points out, however, correlation does not mean causation, and for the FX market, the coronavirus has detracted from the impact of the US elections for now, with investors focusing on the infection rate, the mortality rate and any signs of pockets of infection building outside China. For the next few days at a minimum, says the bank, those three questions – and their impact on risk appetite - will be more important than the US primaries for FX markets. Risk that most directly relates to a China slowdown, like commodities will likely continue to underperform, but risk as it more closely relates to the US economy, and the US elections, should for the time being trade more resiliently, says the bank. DB clients can read the note via the research portal. Click below.