The best way to describe how the equity and currency markets have been trading this month is erratic. This may not be unusual for October, which is historically the most volatile month for stocks, but the market’s ability to ignore major game-changing developments is impressive. The only rational explanation for the 500-point move in the Dow is that investors are looking past near-term political jockeying to the stimulus package that will come eventually. Overnight U.S. President Donald Trump went on a tweet tirade where he said he is ready to sign a stand-alone stimulus bill and, in a show of strength, he returned to work in the Oval Office. Regardless of who wins the election, a major stimulus package is on its way and the only question is how many businesses will survive until then. Equity traders are overly optimistic if they think the House will approve stimulus checks without a broader agreement or that the U.S. economy will avoid further economic pain without stimulus before the end of the year. Equity and currency traders are reacting to every conflicting headline from the White House, and this trend is likely to continue until Nov. 3.
Meanwhile, dovish FOMC minutes kept the U.S. dollar from rallying against most of the major currencies. One of the few exceptions was USD/JPY, which broke a week-long range to trade at its strongest level since Sept. 14. Yet, the rise in Treasury yields suggests that the minutes didn’t really matter to investors. By altering its inflation target and, in turn, its forward guidance, the central bank doubled down on its accommodative policy and made it very clear that interest rates will remain on hold for the next few years. It is open to increasing monetary stimulus, but that’s unlikely unless stocks crash because of a second virus wave in the U.S. or sudden deterioration in Trump’s health.
The best performing currency was the Australian dollar, which shrugged off weaker PMI. According to the latest report, the contraction in service sector activity in Australia deepened with the PMI index falling to 36.2 from 42.5. We’ve now seen evidence of manufacturing and service sector weakness in the month of September that could justify a deeper correction in the Australian dollar. The same was true for the Canadian dollar, which rallied despite a steep drop in IVEY PMI. The index fell to 54.3 from 67.8 last month. Even the move in the New Zealand dollar was counterintuitive as NZD diverged from AUD with no particular catalyst.
The euro rallied despite an unexpected drop in German industrial production. After the sharp rise in factory orders, economists were looking for a 1.5% increase in IP but instead, it fell 0.2%. Virus cases also hit a record high in France and Spain. France is now on its highest alert level, while Spain warned of a very hard few weeks ahead after virus cases topped 800,000. New restrictions have been announced in many Eurozone nations, including Italy and Spain.
Nothing is more important for sterling than Brexit negotiations. Like U.S. stimulus talks, very little headway has been made, and both sides remain too far apart. Most positive headlines have come out of Britain, while most EU headlines are laced with skepticism. At the end of the day, while both sides stand to lose from a no-deal Brexit, the EU has the upper hand and is growing tired of this political dance. An agreement is still possible and the latest rally in sterling is a sign that investors are optimistic. The UK government is close to instituting tighter restrictions, which could slow the country’s fragile recovery.