The only thing certain about present times is uncertainty. From President Donald Trump contracting the virus, the US election with the risk of a disputed outcome, hopes for further US stimulus measures, uncertainties stemming from continued Brexit negotiations, where the risk of a no-deal remains high and rising Covid-19 infections and the implications thereof, continue to roil markets.
On the jobs from front, US job gains slowed in September and many Americans quit looking for work, suggesting the economic recovery is downshifting as the country struggles without a Covid-19 vaccine, or fresh government aid. While the sharp improvement in the unemployment rate to 7.9 percent points to a fast convergence to the Fed’s year-end target of 7.6 percent, this drop was mainly driven by a sizable drop in labour participation as more Americans continue to leave the labour force at an alarming pace. Any hope of a V-shaped recovery led by the labour market is growing dim, especially without further fiscal support.
President Trump has called to stop negotiations on a new stimulus deal, has upended any hopes of a stimulus package being agreed before the election. Given recent expectations, this has put the market in a tailspin given that the only way to stem the current slowdown, rising insolvencies and unemployment, is for a new stimulus package. Clearly, this ongoing uncertainty will keep market volatility more elevated.
While uncertainty persists around the extent of Donald Trump’s Covid-19 infection and that of his close advisors, this clearly does not bode well for his re-election bid. That said, the market continues to price in heightened election extension risk with January volatility now being priced at levels similar to November and with November volatility being priced higher than that for October.
Economic indicators for the Eurozone released last week suggest that the pace of the region’s recovery slowed to a crawl in September. This has affirmed our view that current economic prospects are closely tied with the evolution of the virus, and that the increased virus cases worldwide will likely slow down economies in Q4. Slowing economic growth and a record low in core inflation, may eventually force the European Central Bank to expand its emergency bond-buying programme, potentially driving yields even lower. Moreover, further support will be needed to stem the flows out of European equity funds and ETFs that have seen their third straight week of outflows, as the market comes under pressure.
Uncertainty around the Brexit negotiations persists with the likelihood of a no-deal Brexit, come year-end, remaining high. This is in spite of the latest talks between Boris Johnson and Ursula von der Leyen where no breakthrough was achieved. Moreover, Mr Johnson reportedly re-stated his ultimatum to walk away after the 15 October EU summit, if a deal does not look likely. This continues to weigh on sterling markets and sterling volatility.
The growth and size of central bank balance sheets continue to skew down rates volatility and keep financial conditions supportive. That said, the rising fiscal and political uncertainty will continue to be reflected in rising FX and equity volatility. Depending on the outcome of the US election, this uncertainty may drag on until year-end, causing increased volatility across asset classes.
Whilst volatility across asset classes has fallen since March, volatility it is not at pre-Covid-19 levels. The current uncertainty is causing volatility to rise again. Dispersion and a rise in volatility within and across asset classes is also on the increase into the year-end, making decision making more difficult as the cost of risk increases countered by ultra-accommodative policy decisions resulting in markets trading sideways across most asset classes.
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