BMA Market Insights: U.S. Economy Continues to Rebound

Market Snapshot

USD rates pushing higher this morning with the 10-year U.S. Treasury yield rising 3.5bps, as of this writing, due to renewed hope of a fiscal stimulus deal before the upcoming U.S. election providing investors relief that both Democrats and Republicans continue to speak. Further fueling investor optimism was data overnight from China, the second-largest economy, that showed the economy grew 4.9% in the third quarter. U.S. equity futures point to a higher open with the S&P 500 pointing 0.85% higher pre-market open.

Supply Constraints May be Abating

• Core inflation in September was held down by weakness in the services sector, despite a further surge in used vehicle prices of +6.7% MoM — the largest gain since 1969. This may suggest that the previous upward pressure on prices due to supply constraints may be abating. 
• Core consumer prices rose by a nominal 0.2% MoM after surging by 0.6% MoM in July and a further 0.4% in August.  
• Annual core CPI inflation unchanged was unchanged at 1.7%. 

Consumer Spending Remain Solid

• Retail sales had an unexpectedly strong 1.9% rise in retail sales for the month of September suggesting the economy was carrying more momentum into Q4 than anticipated, defying fears that the expiry of enhanced unemployment benefits in July would hurt the economy. 
• Sales at gas stations rose 1.5% MoM as well as a 3.6% increase in auto sales.
• Clothing sales rose 11% MoM, likely due to a return to seasonal norms in September after an unusually warm summer. 
• Unsurprisingly, as bars and restaurants remained open, the sector saw a 2.1% MoM increase in consumer spending, though still 15% short of pre-pandemic levels.

Manufacturing Output Remains Low

• Industrial Production fell in September  0.6% MoM partly due to a 5.6% MoM fall in utility output. The mining sector saw a surprise 1.7% MoM gain — driven by crude oil extraction and mining support. 
• The primary drag on headline production was a 0.3% MoM fall in manufacturing output, due to big falls in computers & electronics and motor vehicle production. While previous months’ gains were revised up slightly, this leaves manufacturing output more than 6% below its pre-pandemic level and lagging well behind the recovery we are seeing in consumer consumption.
• While the low reading continues to be a concern that the industrial recovery appears to be stalling, it isn’t necessarily a sign that the broader economic recovery is in jeopardy when we know that retail sales rose strongly last month. We expect manufacturing output to pick up soon given the strong consumer demand though the resurgence of new COVID cases poses a further downside risk.

Bet on Inflation Trade Takes Off

Positioning on options on eurodollar futures, contracts that are used to hedge against future yield curve changes, have steadily increased in size over the past week. The strategy is likely based on the thought that a significant fiscal-spending package will increase the velocity of a post-COVID economic rebound which would push inflation towards the Fed’s goal. Investment managers have spent nearly one-million in option premium with a payoff that could earn them a return of 50x. Similarly in the corporate hedging space, markets have not fully priced in a steeper yield curve as seen in the forward LIBOR curves. Downside risk continues to be negative rates, though Fed officials have repeatedly said they do not want or plan to take action.

Weighing heavily on the broader market are:

• The U.S. November Elections
  • While the election risk is somewhat abating due to recent polls, one can recall the polls taken in 2016 that didn’t quite pan out in the U.S. or UK. 
  • Investors and traders are bracing for a volatile election year as the ultimate Presidential and Senate winners may not be known until December, pushing out typical November hedges into December and January 2021.
• U.S. fiscal stimulus package
  • Nancy Pelosi, the speaker of the House, set a Tuesday deadline for more progress with the White House. President Donald Trump renewed his offer to go beyond the $1.8 trillion currently on the table.
  • We may see long-end rates push higher, on inflation expectations, should Congress agree on a $2 trillion+ fiscal stimulus plan.
• U.S.-China relations, as both countries fight on everything from trade to defense issues, monetary policy, and the coronavirus. 
• Second Coronavirus wave
  • Global coronavirus cases surge past 40 million.
  • While there are numerous potential COVID-19 vaccines and therapeutics currently being developed, the limited production capabilities, timing, and acceptance for people to receive the medical solutions are of concern and could be drawn out to the end of 2021.

Up ahead this week: