Risk sentiment has been relatively constructive this week, as data has generally been on the positive side amid positive tones of a potential new US fiscal stimuli package. European rates continue to be range bound in a tight range and we expect Bunds to stay in a -60bp to -40bp range in coming months, amid record-high excess liquidity in the system after the TLTRO 3.5 liquidity operation from the ECB pushed short-end rates lower.
At the ECB Watchers Conference this week, ECB President Christine Lagarde gave a detailed speech about the ongoing strategic review in which she opened the way for examining the merits of inflation make up strategies, similar to the Fed (AIT). She did not indicate any pre-emptive conclusions of the outcome, although including owner-occupied housing in the inflation measurement and potentially giving core inflation a more prominent role may be a likely outcome in our view. She did not give any indication on the near-term policy stance. The ECB is due to release the minutes from its September meeting on Thursday, which should shed light on the economic and inflation debate heading into Q4 and 2021. We still do not expect the ECB to recalibrate the Pandemic Emergency Purchase Programme (PEPP) this year, believing it is more likely to do this next year. Yesterday, ECB Vice-President Luis de Guindos outlined that a reaction function of financial tightening, inflationary outlook and fiscal response would determine the evolution of PEPP. We are also due to get the minutes from the September FOMC meeting and we intend to focus on the discussions about the inflation target strategy and about more QE.
In the US, the first debate between President Trump and Joe Biden did not provide much news, as Trump and Biden kept interrupting each other. Hence, there was little debate on politics, so it did not leave a mark on markets. With the nomination of new Republican Supreme Court judge Amy Coney Barrett, it seems set to be difficult to approve a new US relief package before the US presidential election, despite the positive tones from House Speaker Nancy Pelosi, who said that she has spoken with US Treasury Secretary Steven Mnuchin, as the Democrats seem to have lowered their demands. The White House and Pelosi are still around USD1,000bn apart, so an agreement still seems at least some time down the road.
Brexit is becoming increasingly tricky, most recently with the EU launching a legal action against the UK for breaking the already-approved withdrawal agreement. We assign a 60% chance to a deal and 40% to no deal. The Bank of England (BoE) is currently working on a study of the prospects of a negative interest rate. In the event of a hard Brexit, it may need this tool. In our view, to have a material impact on markets, the BoE would have to ‘go big or go home’, so a 50bp cut could come. Our base case is for a deal in November.
Next week, we expect focus to be on the spread of COVID-19 and on whether local lockdown measures are starting to pay. It is a relatively slow week in terms of key data releases, where globally we expect Chinese PMI to draw the most attention with the September Caixin PMI. The Chinese economy has recently rebounded solidly, as activity is picking up again. Hence, we also expect to see another relatively strong report on Thursday around the 54 level. In the euro area, hard data should tell us how the economy fared in Q3, with retail sales for August (which we believe are likely to look good) and final services PMIs for September (which we do not expect to share the otherwise good manufacturing PMIs that we got this week).
