Risk Off / Risk On
MARKETS ENDING 2020 IN ‘RISK ON’ MODE
The past w eek has brought further sombre Covid-19 news with cases continuing to rise sharply in many countries. As a result, higher levels of restrictions have been imposed across much of Europe including the UK. Controls are looser across most of the US but with Covid-19 cases still rising sharply there, that position may change in the new year.
Despite those adverse developments, the mood in markets remains relatively upbeat. The start of Covid-19 vaccine rollouts in the UK and the US, and the hope that other countries may soon follow suit, has lifted sentiment. In addition, hopes that the US Congress may soon (possibly even today) pass additional fiscal stimulus is helping raise growth expectations.
Against this background, most global equity markets w ill probably end the last full trading w eek of the year up. After a brief slump in the early days of the pandemic , equities have subsequently rallied sharply and most markets w ill end the year up led by the US. Meanwhile, government yields continue to see little movement with most stuck in fairly tight trading ranges that are above their low s for the year but w ell below pre-pandemic levels.
In currency markets, the US dollar has been under pressure this w eek as has been the case for most of this year w hen the market mood has been ‘risk on’. As a result, sterling has touched its highest level since May 2018 against the greenback. The pound is also up on the w eek against a generally strong euro as traders factor in a higher probability of a Brexit deal. How ever, here, it is still below its level for much of November.
BREXIT OUTCOME REMAINS UNCERTAIN
Despite renewed market optimism, it is still uncertain whether the UK and EU w ill be able to reach an agreement on trade before the end of the UK’s transition period on 31st December. A number of recent comments have sounded more hopeful and EU chief negotiator Barnier said on Thursday that a deal w as possible by the end of Friday. How ever, a spokesperson for UK PM Johnson pointed to continued sticking points notably on fishing policy. Consequently, it seems likely that talks w ill continue into the weekend and possibly into next week.
That will leave only a few days for the UK and European parliaments to vote on any deal. The UK parliament stands ready, if necessary, to reconvene either next w eek or after Christmas. How ever, the European Parliament has said that a deal needs to be done by Sunday if they are to vote before the end of the year. Failing that, a provisional arrangement may need to be put in place and the final deal ratified later.
Whatever the outcome of the talks, both sides will need to get used to a new trading relationship from the new year. Amongst other things, that w ill involve a greater amount of paperwork at ports and other international entry points. The UK has said that it will delay implementation of this until July but the EU plans to put it into immediate effect, which may lead to near-term delays and bottlenecks. Ahead of this, there have already been reports of holdups. The December UK PMI report pointed to “severe pressure” on supply chains due to problems at ports even before the new arrangements are in place.
LIGHT CALENDAR OVER THE FESTIVE PERIOD
The economic calendar over the festive period is light. Analysts will continue watching the markets for an improvement in business sentiment in the wake of the positive news on vaccine rollout. The data was collected prior to the most recent upgrade in restrictions but near-term Covid-19 concerns and Brexit uncertainty will probably still be offsetting factors to some extent. Next w eek also has a second reading for Q3 GDP, which is expected to be unchanged from the initial estimate of +15.5%q/q and a public finances update for November.
The first week of January w ill see final readings for the December UK manufacturing and services PMIs. The initial out-turn for manufacturing w as stronger than expected, supported by Brexit preparations but services disappointed with the index up from November but still below the 50 level. We expect modest upward revisions for both with manufacturing up to 57.5 from 57.3 and services to climb to 50.1 from 49.9. We also forecast the construction index to be 55.0 in December up from 54.7 in November. Despite this, it is likely to be a challenging start to 2021 for many sectors given the recent tightening in restrictions. Revised Eurozone PMI data w ill also be released in early January. We expect the manufacturing measure to be unchanged but services may be revised up modestly.
In the US, this w eek’s larger-than-expected fall in November retail sales, and a second w eek of much higher-than-forecast jobless claims, has added to concerns that economic grow h is slowing sharply. Next week’s November consumer expenditure update w ill provide further evidence on this. As a wider measure of spending than retail sales w e expect it to fall by less, but nevertheless look for a drop of 0.3%. Early in the new year, the December labour market report w ill be watched for further signs that the rebound in employment is stalling. The November report disappointed and the recent rise in claims for unemployment suggests that December may also disappoint. We look for a further slow down in employment and an unchanged unemployment rate. Also of interest in the first w eek of 2021 w ill be the ISM manufacturing and services surveys for December.
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