Risk Appetite Has Returned After Last Week’s Turbulence

Risk appetite has returned after last week’s turbulence. European bourses rose 1-2% in early trade on Monday after Wall Street’s rally on Friday lifted the boats. The S&P 500 was still down for the week but with the broad market -10% from its all-time highs at the low, those looking for a correction after the hot summer rally may have found it already. The market tested 3200, which is where it reached at the peak in June before the pullback and where it closed 2019. Bonds have not taken part in the drawdown – US 10-year Treasuries have barely budged this month and remain stuck around 0.66%. This might imply that the September sell-off is more about a repricing of risk assets based on valuations and profit-taking after the summer run-up, rather than deeper fears about a prolonged stagnation in the economy. Nevertheless, with the first US presidential debate and the last jobs report before the election coming this week, there is ample scope for markets to remain volatile. Until we clear the highs from a fortnight ago – 3400 on SPX, around 3300 on Stoxx 50, and 6,000 on the FTSE, the downside bias remains.  Rising numbers of coronavirus cases imply a softer recovery, depressed consumer sentiment, and the need for more fiscal support to generate upside. Markets don’t seem to be moving too much on vaccine news and rumors – there may be a realization that a vaccine is not a silver bullet that will repair all the damage done in 2020, even if it makes 2021 look brighter.

HSBC shares rallied 10% after Ping An Asset Management increased its stake in the bank. HSBC’s largest shareholder only marginally bolstered its holding to 8% from 7.95%, but the vote of confidence translated into a very substantial rally for the shares both in Hong Kong and London. HSBC had lately sunk to a 25-year low after being named in reports relating to money laundering, so maybe this was some simple averaging-in by Ping An. Shares are only back to where they were a fortnight ago - when stocks have been beaten down as much as HSBC they are often ripe for larger percentage swings as investors try to figure out what is the real value. If you think Britain’s banks are fundamentally sound, shares are priced compellingly. Lloyds (LON:LLOY) at 25p trades at 0.35 of book value.  

Bank of England rate setter Silvana Tenreyro defended negative rates in an article over the weekend, in what we could construe as a careful piece of choreography to communicate the bank’s shift towards a state of outright financial repression. She said there were ‘encouraging’ signs that there are no longer the same obstacles to cutting rates to below zero. But she’s been positive on negative rates for several months so we should probably not read too much into her comments. Andrew Bailey remains the most important voice of the MPC and whilst he did not seek to quell speculation last week that the Bank is considering how to use negative rates, he did stress that it’s not in a hurry to pull them out the toolbox. 

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Brexit talks resume this week and despite all the noise, both sides want a deal. Whilst the UK threw a spanner in the works with the internal market bill, the real substance of the trade deal is what matters. On that front, the EU and UK are about 90% there. The problem is the remaining elements and without these sorted, there is no deal. Nevertheless, there is hope that they will enter the ‘tunnel’: the period of closed, detailed talks that would lead to a deal. If there is white smoke this week then the sterling will rally strongly, but I would expect this to drag on for a while longer, for deadlines to be missed and for GBP crosses to remain exposed to negative headline risk. 

The euro retained its downside bias after more jawboning from the ECB.  Ignazio Visco, Italy’s central bank governor, said the euro's recent strengthening is “worrying us because it generates further downward pressures on prices at a time when inflation is already low".  A slate of ECB speakers this week is likely to lean hard on governments to deliver fiscal support.

Chart: GBPUSD tests near-term resistance at 1.28