Excerpt from November 10th:

The US and China are the current engines of growth, keeping the global recovery on track. A vaccine only reinforces the recoveries in China/US, and should eventually put Europe back on a stronger footing

The three main engines of global growth – the US, China and Europe – are operating at different speeds, but their combined impact should be enough to keep the global recovery from stalling.

In the US fiscal stimulus is a neutral risk at the moment. Now that the blue sweep favoured by the polls looks less likely to materalise, the kneejerk response has been that fiscal stimulus will be harder to pass due to political “gridlock”.  For now, though, markets are not pricing this as a calamity, with some degree of stimulus still expected.  This was even before Pfizer’s announcement on the purported success of their vaccine.

More importantly, yields are well above where they were at the beginning of October, when a blue sweep began to be priced.  Arguably, if a blue sweep was a foregone conclusion, yields would have been pushing towards 1%.  As it happens, the vaccine announcement has had a similar effect, with 10y yields getting back in to the mid-90bps range (currently mid-80s).

Moreover, this rise has been driven all by term premium.  If a more pessimistic scenario was foreseen for the US economy, term premium would likely be falling as the market anticipated a significant increase in QE.

Charts Source: Bloomberg, Macrobond and Variant Perception

A Democrat win with a likely divided Congress is for now risk-on.  A potential vaccine amplifies this trend.  We saw some derisking before the election, with macro funds in the aggregate reducing their beta to the equity market to zero, but they are now tentatively long again.  Ditto CTAs.  Also the put/call index ratio has stopped rising.

Charts Source: Bloomberg, Macrobond and Variant Perception

There is a general reflationary impulse that is supportive of risk-on behaviour.  Our leading indicator for copper has turned up sharply.  This consistent with a rising copper/gold ratio and rising term premium.

Charts Source: Bloomberg, Macrobond and Variant Perception

The prospect of a renewed national lockdown remains a negative risk for the US market, but one that is more blunted since the elections and the most likely final outcome of a divided House.  Moreover, as we have previously argued, given the heterogeneity of the US states with their own legislatures, the economic impact is overall less compared to more unitary-run countries such as those in Europe.

Indeed, the set of renewed de facto national lockdowns in Germany, Spain, France, the UK and Italy imperils the very fragile European recovery, and increases the risk of a double-dip recession in the eurozone.  The link between virus cases and economic activity is currently strong in Europe as governments have based policy on extrapolations of case growth, rather a combination of case growth, hospitalisations and clinical outcomes.  Nevertheless, there are signs case growth is rolling over in Europe, and the doubling time of case growth is rising again.

Charts Source: Bloomberg, Macrobond and Variant Perception

It is probably too late for the European economy, though, given the fragility of its recovery.  This is one engine of growth that will be absent for the time being.  However, a slump in Europe is unlikely to be enough to derail the global recovery and the cyclical/defensive rotation, as the China engine of growth remains strong.

Our China short-leading indicator remains constructive and is one of the few countries that will likely realise future gains.  Even as parts of Europe renew lockdowns, the reflation from the rest of the world points to further gains in Chinese leading data.

Charts Source: Bloomberg, Macrobond and Variant Perception

While China’s policy response is much more measured compared to the West, its credit and liquidity expansion will have an outsized impact for industrial sectors and economies.  This will likely drive a wedge between the recoveries of European countries.  Germany is well-placed to recover after lockdowns end, given it is particularly exposed to China and has generally handled the impacts of the pandemic comparatively better.  It is therefore unsurprising that our France, Spain and Italy LEIs are not rebounding as strongly as Germany’s.

The China and US engines growth are enough to keep the global recovery on track.  China’s recovery should soon feed back into Europe, restarting its engine.  All engines will benefit from the development of an effective vaccine.