Asia Session: Reflation Trade Gaining Traction, Election Chaos Fear Eases

US equities and oil prices continue to pare last week’s losses, while the UST curve is steepening. US President Trump has been discharged from the hospital following his COVID diagnosis the previous week. By reducing uncertainty around his ability to lead the Republican campaign to election day, the reaction has been positive for risk assets.
 
Growing expectations for US fiscal stimulus have been rising in parallel with the President’s hospitalization, judging by the bearish steepening in the UST curve.
 
The timing of fiscal stimulus becomes essential at some point. Still, for now, the increasing possibility of a Biden presidency (64% vs. 59% a week ago, according to PredictIt) and a Democrat-majority House (88% vs. 85%) and Senate (67% vs. 58%) should prove reflationary for financial assets that boost commodities (e.g., , , ) and high-beta risk currencies (e.g., ).
 
The primary risk to reflation trades is a boost for President Trump in the polls. It will take a few days before the impact of the President’s illness filters into the election polls. This matters because polling in the swing states suggested a much closer result than implied by prediction markets. I expect more volatility to pick up, especially in oil prices, which I suspect will still play out as a key barometer for election risk.
 
However, President Trump is unlikely to turn volte-face and take the US down the much more restrictive path around tightening social mobility measures, as Johnson’s UK government did. Instead, the President could take a leaf out of Bolsanaro’s book by doubling down and further downplaying the pandemic. This approach is unlikely to pull in undecided voters.
 
I am not a political scientist, but I have mastered the art of statistical analysis after 2 + decades in the hot seat (G-10 Chief Trader). And given the improvement in gathering accurate polling data since the 2016 debacle, the polls’ consistent run suggests the race is Bidens to lose.

Fear and Chaos

Fear of election chaos is slowly dissipating as odds of a Blue Wave rising and the dreaded Red dragon drop. But when a market is prepared for chaos, expect a lack of market chaos. Extreme volatility is a product of surprises, not desired outcomes.
 
Ironically, now that the Red mirage and the Trump miracle has been priced out, the potential for market chaos has risen again.
 
Most everyone seems to agree that a Blue Wave would be bad for the and potentially bad for bonds, and that is the way markets have been moving.

The market seems to have settled on the idea that a Biden win is bullish stocks, too, as the return of stability and the promise of MMT-style spending outweigh any concerns about future tax hikes. Trump win: Good for stocks. Biden win: Good for stocks which should provide that clear road to Nirvana, right?

Maybe but there is that small matter of term premium getting priced into the bond yield equation, which will upset the equity apple cart and if the Fed stops monetizing all debt.
 
Anytime the market starts to price in a regime shift, look for volatility to spike as policy uncertaintly most certainly will come to the fore. 

Overnight Recap

US equities were stronger Monday: The closed up 1.8%. Helping sentiment was a favorable prognosis for the President’s COVID infection. Doctors treating the President indicated that he had met specific discharge criteria and was discharged from hospital this morning Asia time. The better sentiment was also reflected in bonds, with yields rising a notable 7bps to 0.77%. Oil lifted 5.9%.

Oil Markets 

I am still not bought into the oil rally, and I expect any fiscal bounce to be faded as in the absence of a vaccine, the risk of COVID case count risk in the northern hemisphere, at some point, is bound to be a rally capper.

We can already see its temper in price action in Asia today on the back of a combination of fiscal uncertainty, and rising COVID case counts worldwide. But indeed, the more significant the delay on a fiscal package, the more antsy markets will get.
 
I still think oil plays the role of a Biden barometer where the ESG and the Democrat’s left-wing greening agenda will act as a deadweight for oil prices in 2021. OPEC is already targeting a $50 average. Hence, as moves to $45 given the volatility and when combined risk-reward of owning oil contracts above that level, the bullish will likely dissipate in the absence of a vaccine. So not a lot of topside dollar to work with on that view. 
 
The bottom line for oil is relatively straightforward. It is hard to imagine any scenario in the near-term where travel gets back to pre-pandemic levels. Even with a vaccine in the pipeline (which there are numerous), there are gnawing concerns that we are not in “Pump PumP Pump” oil patch Nirvana anymore or ever will be again. 
 
FOREX
 
The bearish USD story is tricky because a lot of Blue Wave is priced in and also because many contra currencies in any G10 USD trade have problems of their own:

  •  EUR: Inflation diving, rate differentials on the move (bearish ) background angst about the recovery fund text
  • AUD: tonight unlikely to deliver meaningful action, but there is the possibility of a dovish (and currency-negative) surprise if RBA goes RBNZ style and elects to buy bonds in the 5-10-year bucket
  • JPY: does not move. I am short anyway because I like the entry point. 
  • GBP: Brexit plus the on and off again obsession with negatives rates make an idiosyncratic story and not a fair USD trade.
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