Between the market close on 2 November, the day before the US presidential election, and the close on 9 November, global equities rose by 7.6% (MSCI AC World index in US dollars) to reach an all-time high, as did the Dow Jones index (+8.3%). The extraordinary advance came as Joe Biden steadily progressed towards the US presidency and and the incumbent started legal action. The gains were extended as positive vaccine trial news fired investor hopes of an end to the pandemic.
On the US political front, not everything went exactly as expected or on time. Joe Biden was able to claim victory only on 7 November, and the ‘blue wave’, that is, the strong endorsement of Joe Biden and the broader Democratic Party, did not come to pass.
This forced investors to revise their central scenario of hopes for a large fiscal stimulus backed by Democratic control of Congress. While the Democratic Party retained a (smaller) majority in the House of Representatives, its chances of controlling the Senate received a blow. Runoff elections on 5 January for two Georgia Senate seats will now determine which party will be in the driving seat.
Investors now face the prospect of lower-than-expected budget spending, but without the tax increases that would have accompanied a more generous package. The chances of tech giant regulation also receded. Equity investors, particularly those in large caps, judged the balance to be positive and drove prices higher. Long-term yields fell, reflecting the lost inflation impulse.
A definitive certification of the results by the Electoral College will have to wait until 8 December.
Relief, if not enthusiasm, over the election combined with news of a vaccine which was 90% effective in the third phase of clinical trials. In response, equities soared and long-term yields rose. The 10-year Treasury yield, which had already risen to above 0.80% on Friday after better-than-expected payroll data in the US, ended Monday’s trading above 0.90%, its highest level since mid-March. The German 10-year yield rose by 11bp, moving back toward the ECB’s deposit rate (-0.50%).
Many questions remain concerning the efficacy of the vaccine on larger samples, its safety, the timing of any FDA approval, large-scale production and logistical issues, and the level of acceptance by individuals. The coming weeks and months will likely be marked by disappointments and new hopes depending on the progress made by this and other laboratories.
While some recent data has been encouraging, economies in Europe are beginning to feel the effects of renewed lockdowns, particularly on the employment side. Even with only partial lockdowns, we expect a contraction in GDP in Q4. The lockdowns are also weighing on confidence, as illustrated by the drop in the German ZEW optimism index (see Exhibit 1). Industrial production in Italy fell by much more than expected in September.
The latest ECB bank lending survey found that lending standards for business and households had tightened in Q3. This broad slowdown is raising expectations for additional support from the ECB come December. ECB officials have been reinforcing President Christine Lagarde’s recent message that ‘all Instruments’ will be adjusted in December towards more accommodation. Debates within the ECB appear to be focused not on whether security purchases will increase, but by how much.
The Bank of England has already increased the size of its asset purchase programme and its key rate may be cut to below 0%.
The Federal Reserve‘s analysis of the economy remains cautious. It did not change monetary policy last week, but the Federal Open Market Committee did discuss possible changes to the Fed’s asset purchase programmes. Some observers expect the Fed to adjust the size or the composition of its asset purchases in December. Furthermore, various credit facilities put in place in March and April could be extended beyond the end of the year.
While the resurgence of the COVID-19 epidemic poses short-term risks to economic activity, the prospects for a vaccine appear to have improved. We have not changed our medium-term scenario and believe economic and central bank policies remain supportive of equities.
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