Next Week's Risk Dashboard

• Brexit’s final act?
• US funding & stimulus talks
• A Fed preview
• Other CBs: BoE, BoJ, SNB, Norges, Banxico…
• …BanRep, BI, Philippines, CBCT, Russia
• PMIs: Eurozone, US, UK, Japan, Australia

Chart of the Week

The coming week will serve as another reminder of how global political leadership has offered a mixed set of influences upon the economy and markets over 2020. Exemplary work by governments and their (sort of) independent central banks to deliver major fiscal and monetary policy stimulus has helped to nudge economies and markets into recovery. They will gradually shift toward complicated and equally taxing matters governing how to ultimately transition away from such assistance, but we would all be in a worse state if not for their actions, hard work and devoted service.

This nevertheless followed a failure to enact pandemic planning measures after years of warnings by health policy experts and scientists. We’ve all no doubt filtered out bad things that might happen and failed to fully take preventative steps as it’s a somewhat human thing to do. But steps taken toward sharply reducing hospital beds per capita and straining health sector funding across virtually all OECD economies for many years leading up to the pandemic while failing to make relatively token investments in stockpiles of emergency supplies such as vents and N95s probably made the pandemic even worse than it would have otherwise been. It’s as if pandemic plans were drawn up and then promptly shipped off to archives never to see the light of day again. Thank you for the band-aid; not for the wound. Fortunately we have brilliant scientists to thank for developing vaccines that hold forth the best prospect of a sustainable recovery that would not have otherwise been possible. In my view, they are the true heroes in all of this.

That is, of course, unless we find other ways to ruin it all or at least make the path to full recovery take longer and proceed along a bumpier road. Enter the week ahead. Transition to the present and it’s frankly astonishing to even remotely contemplate actions to destabilize the picture in the middle of the global second wave of COVID-19 cases. Great Britain crashing out of Europe? The US even talking of the risk of a government shutdown that would disrupt services into the holiday season? Yoo hoo, is that you Ebenezer? Toying with cutting off jobless benefits for millions of unemployed Americans and booting them from their homes come January 1st because of the inability to agree upon extending CARES Act stimulus while setting aside tangential political matters mostly attached to individual personalities? Toying with the public’s confidence in democratic institutions? Or how about no one talking about unwinding the results of destructive trade wars over 2018–29. The age of policy via Twitter has been rather short on true states(wo)men. Forgive me for saying so, but quite frankly, every time I hear someone standing at a pulpit and admonishing the private sector on grounds of what’s fair and inequality I can’t quite help but point out that discrete and long lasting leaps toward regressive outcomes are often the by-product of repeated, costly policy failures. The way to fix that in future is less about how much is spent trying, and more about avoiding large and repeated policy mishaps. Maybe a little more effort in that regard will help understand why there is deep-rooted cynicism across today’s electorates and present populist tendencies.

I’m cautiously if not perhaps hopelessly optimistic toward how this ultimately plays out over the coming week, but the damage is already being done. The destabilizing influences upon how businesses and households can plan through this environment are not helpful. Judging by the antics in major capitals like Washington and London, it would appear to an outsider from another universe as if there could not possibly be a major global pandemic that is still underway.

1. BREXIT—DOWN UNDER, INDEED

UK PM Johnson advised on Friday that a hard Brexit on January 1st is “very, very likely.” He enters last ditch negotiations with EC President von der Leyen through Sunday that has been set as decision day.

It’s quite dumfounding that in the midst of a pandemic, a once great Empire and still powerful nation would seriously court the prospect of entering 2021 sans trade agreements with its main trading partners in Europe and America. Bookies are wagering rising odds that it’s over (chart 1). Truth is indeed stranger than fiction in our times as this remains a very real possibility.

 

Still, it is not yet a certainty. There is a small chance that the outcome won’t be so blindingly stupid as to impose a trade shock on the UK economy with businesses and households reeling from second wave COVID-19 effects. As Irish PM Varadkar put it “It’s very often the case that these deals are done at the last moment because everyone needs to be sure it was the best deal possible and there is nothing else left on the table.” Think, for example, of the CUSMA/USMCA NAFTA 2.0 negotiations that involved Canada drawing a line in the sand on multiple issues only for Trump to cave and a relatively favourable deal to be struck as opposed to giving notice that the US would walk away and inflict a self-imposed gunshot wound on its own economy. In a sense, Brexit may be no different from the kind of brinksmanship we’ve seen in other tense negotiations.

Nevertheless, to candy coat this hard exit risk, UK Prime Minister Johnson has advised that the most likely outcome stemming from talks this Sunday is that the so-called Australia model will govern EU-UK relations into the new year. This is a euphemism for a hard Brexit absent a deal without directly saying as much, as opposed to the so-called Canada model of an independent country with a more favourable trade agreement with the EU than that which would govern trade under WTO rules. The Australia model would involve the UK relationship with the EU reverting to WTO rules governing trade between the two powers including tariff schedules, regulations and quotas. Even Australia is trying to extricate itself from this arrangement with the EU by seeking an alternative bilateral deal! It is because of higher uncertainty and tariff schedules under the Australia model that sterling has been depreciating in anticipation of a terms of trade shock to the UK economy.

2. CENTRAL BANKS—IT ALL COMES DOWN TO WAM

A slew of central banks will deliver policy decisions over the coming week, including a mixture of major and regional players. Most of them weigh-in a day or two following the Federal Reserve. That seems appropriate since, for the most part, what the Fed may do is where most of the global market risk may reside.

i) FOMC

The Fed is certain to introduce new communication tools on Wednesday and will probably introduce forward guidance for its asset purchase program. What it might do with the scale and scope of its asset purchase program is more uncertain. The statement arrives at 2pmET on Wednesday followed by Chair Powell’s usual press conference starting a half hour later.

Asset Purchase Program Guidance

Minutes to the November 4th–5th FOMC meeting noted that “most participants” judged that guidance for asset purchases should be updated “at some point” which leaves it somewhat open to whether they will do so as soon as this coming meeting or into 2021.

Recall that, to date, purchase program guidance has stated that holdings of Treasuries and MBS will be increased “to sustain smooth market functioning and help foster accommodative financial conditions, thereby supporting the flow of credit to households and businesses.” With financial market conditions having healed rather robustly since earlier in the pandemic, this form of guidance has a bit of a stale feeling to it. This leaves markets debating the criteria that would be applied to decisions on how much longer to buy, under what conditions it may continue to do so, when it may begin to taper purchases, and ultimately when the program may be shut down and transitioned toward reinvesting coupon and maturing flows before ultimately unwinding. These are key considerations to market participants in that they inform expectations surrounding whether to follow the same exit playbook as the post-GFC period.

What form could such guidance take? In the same minutes, it was noted that most participants felt that qualitative outcome-based guidance that links purchases to economic conditions over time would be advisable. The purpose of doing so would probably be to clarify to markets the intent of guiding purchases until the path toward full employment and the inflation target is well underway as opposed to guidance to date that has been less explicitly linked to expected future economic conditions. What leans toward this change occurring now is that only “a few” participants thought it shouldn’t be made in the near-term given economic and market uncertainty.

More Robust Communications

At the November 5th press conference following that day’s FOMC statement, Chair Powell noted that the December meeting’s communications will change in two modest ways. One is that they will now release the whole Summary of Economic Projections materials at the same time as the statement (2pmET) instead of three weeks later in the minutes. Second, they will add two new graphs that show how the balance of risks has changed by participant over time. That could offer useful information on the breadth of the policy bias and how it is shifting over time. When combined together, these added tools could give a better evolving sense of the confidence that FOMC officials have toward the outlook.

Changing the Purchase Program

It is also possible that the FOMC decides to alter its purchase program in a more substantive and immediate way. The FOMC is unlikely to alter the total of Treasury and agency MBS purchases from the present US$80 billion and US$40 billion per month rates, but it could push out purchases further along the curve in such fashion as to alter the weighted average term to maturity of its holdings (WAM). Chart 2 shows the weighted average maturity of Treasury holdings at the Fed while chart 3 shows the distribution of purchases by maturity bucket this year. What may lessen pressure to act now is that the prior upward movement in, say, the 10 year Treasury yield has recently abated. The tone of public comments by FOMC officials also tends to lean against anything being done imminently.

 

For example, the minutes to the November meeting stated that “participants generally saw the current pace and composition as effective in fostering accommodative financial conditions” and “While participants judged that immediate adjustments to the pace and composition of asset purchases were not necessary, they recognized that circumstances could shift to warrant such adjustments."

FOMC guidance since the publication of the minutes has also not conveyed much of a sense of urgency. Chair Powell passed on opportunities to materially broach the topic in his quarterly CARES Act testimony before Congress on December 1st and 2nd. St. Louis Fed President Bullard (nonvoting 2020) remarked that “I do think we have a robust program in place right now and I don’t see any reason to change it.” NY Fed President Williams commented that financial conditions “are quite favourable.” Perhaps most telling of all were comments by Dallas Fed President Kaplan (voting 2020) on December 2nd:

“When you have this kind of situation, where you’ve got a three- to six-month issue, but over the horizon we expect strong growth—I think dealing with that may be more suited to fiscal policy. I don’t know that increasing the size or extending maturities of our bond purchases would help address the situation I’m concerned about in the next three to six months. I would not want to do that at this point. I’ll go into the December meeting with an open mind but I think we’ve got very accommodative financial conditions.”

ii) Other central banks

On Thursday and Friday, no fewer than nine other central banks will weigh in with updated assessments. The Bank of England is not expected to alter its asset purchase target of £875B or 0.1% Bank Rate but obviously the state of Brexit negotiations this weekend and the outcome into the new year and how markets take it may be impactful to its assessments.

Banxico, the Swiss National Bank, Norges Bank, Bangko Sentral ng Pilipinas and Taiwan’s central bank are not expected to alter policy on Thursday. The Bank of Japan is also expected to stay on hold along with BanRep. Russia’s central bank is expected to hold at 4.25% on Friday with a minority expecting a cut.

3. DOES A SCORNED TRUMP UP THE RISKS TO US STIMULUS & FUNDING TALKS?

Little progress was made this past week toward an omnibus funding bill and stimulus package. The companion efforts will continue over the coming week.

As this past week came to a close, the Senate followed the House of Representatives in passing a one-week Continuing Resolution to fund government agencies until Friday December 18th. The Senate also passed a defence spending bill by a veto-proof margin against President Trump’s wishes. Trump had opposed the bill because it proposed renaming military bases presently named after Confederate leaders and because he wanted to use the bill to seek vengeance against social media companies.

With Trump having lost this battle to Congress, it’s unclear whether the odds of obtaining his signature may be jeopardized on an omnibus funding bill to keep the government open past this coming Friday and a stimulus package to extend CARES Act measures that would otherwise expire on December 31st—like jobless benefit enhancements and an eviction moratorium. There is enough scope for disagreement on a stimulus package between GOP members and Democrats with major bones of contention including liability protection for companies against COVID-19 suits that the Republicans wish to include but the Democrats oppose, as well as aid to states that the Democrats are seeking. Then layer onto that risk the President’s personality on his way out the door.

As argued in last week’s Global Week Ahead (here), shutdowns normally illicit a minimal impact on the economy and markets. This one remains different given Trump’s proclivity toward tearing the house down in the pursuit of his own single-issue aims as he did with the late 2018–19 record-long government shutdown over funding for the Mexican border wall. That period coincided with a significant hit to equities, albeit in the context of multiple other developments (chart 4).  

 

4. PMIs TO INFORM Q4/Q1 TRANSITION

A wave of purchasing managers’ indices start up anew over the coming week. The December readings will further inform Q4 GDP growth-tracking, but also how economies are transitioning into 2021. Charts 5–9 show the recent connections between PMIs and GDP growth and where they are pointing into Q4.

 

Japan kicks it off on Sunday night eastern time with the Q4 Tankan survey before the Jibun gauges arrive on Tuesday.

Australia reports PMIs on Tuesday evening (eastern time).

US releases will include the Empire regional manufacturing report on Tuesday, Markit’s manufacturing and services PMIs on Wednesday, and the Philly Fed’s regional gauge on Thursday. The Empire and Philly measures will begin to indicate where the next ISM-manufacturing reading could go when it gets updated on January 5th.

UK and Eurozone PMIs arrive on Wednesday. The German IFO business confidence measure will also be updated on Friday. 

 

 

 

 

 

 

DISCLAIMER

This report has been prepared by Scotiabank Economics as a resource for the clients of Scotiabank. Opinions, estimates and projections contained herein are our own as of the date hereof and are subject to change without notice. The information and opinions contained herein have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. Neither Scotiabank nor any of its officers, directors, partners, employees or affiliates accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or its contents.

These reports are provided to you for informational purposes only. This report is not, and is not constructed as, an offer to sell or solicitation of any offer to buy any financial instrument, nor shall this report be construed as an opinion as to whether you should enter into any swap or trading strategy involving a swap or any other transaction. The information contained in this report is not intended to be, and does not constitute, a recommendation of a swap or trading strategy involving a swap within the meaning of U.S. Commodity Futures Trading Commission Regulation 23.434 and Appendix A thereto. This material is not intended to be individually tailored to your needs or characteristics and should not be viewed as a “call to action” or suggestion that you enter into a swap or trading strategy involving a swap or any other transaction. Scotiabank may engage in transactions in a manner inconsistent with the views discussed this report and may have positions, or be in the process of acquiring or disposing of positions, referred to in this report.

Scotiabank, its affiliates and any of their respective officers, directors and employees may from time to time take positions in currencies, act as managers, co-managers or underwriters of a public offering or act as principals or agents, deal in, own or act as market makers or advisors, brokers or commercial and/or investment bankers in relation to securities or related derivatives. As a result of these actions, Scotiabank may receive remuneration. All Scotiabank products and services are subject to the terms of applicable agreements and local regulations. Officers, directors and employees of Scotiabank and its affiliates may serve as directors of corporations.

Any securities discussed in this report may not be suitable for all investors. Scotiabank recommends that investors independently evaluate any issuer and security discussed in this report, and consult with any advisors they deem necessary prior to making any investment.

This report and all information, opinions and conclusions contained in it are protected by copyright. This information may not be reproduced without the prior express written consent of Scotiabank.

™ Trademark of The Bank of Nova Scotia. Used under license, where applicable.

Scotiabank, together with “Global Banking and Markets”, is a marketing name for the global corporate and investment banking and capital markets businesses of The Bank of Nova Scotia and certain of its affiliates in the countries where they operate, including; Scotiabank Europe plc; Scotiabank (Ireland) Designated Activity Company; Scotiabank Inverlat S.A., Institución de Banca Múltiple, Grupo Financiero Scotiabank Inverlat, Scotia Inverlat Casa de Bolsa, S.A. de C.V., Grupo Financiero Scotiabank Inverlat, Scotia Inverlat Derivados S.A. de C.V. – all members of the Scotiabank group and authorized users of the Scotiabank mark. The Bank of Nova Scotia is incorporated in Canada with limited liability and is authorised and regulated by the Office of the Superintendent of Financial Institutions Canada. The Bank of Nova Scotia is authorized by the UK Prudential Regulation Authority and is subject to regulation by the UK Financial Conduct Authority and limited regulation by the UK Prudential Regulation Authority. Details about the extent of The Bank of Nova Scotia's regulation by the UK Prudential Regulation Authority are available from us on request. Scotiabank Europe plc is authorized by the UK Prudential Regulation Authority and regulated by the UK Financial Conduct Authority and the UK Prudential Regulation Authority.

Scotiabank Inverlat, S.A., Scotia Inverlat Casa de Bolsa, S.A. de C.V, Grupo Financiero Scotiabank Inverlat, and Scotia Inverlat Derivados, S.A. de C.V., are each authorized and regulated by the Mexican financial authorities.

Not all products and services are offered in all jurisdictions. Services described are available in jurisdictions where permitted by law.