Another week closer to the end of this extraordinary year and stock markets are generally a bit higher. Last week I said I thought we might be in for a setback as the good news on the vaccine was all priced in, investors were complacent, there are rebalancing flows with equities being sold, and weak data to digest.
Yet despite all that, the rally continued, and I have to concede now that I got it wrong and we’re probably headed for a Santa Claus rally.
We have had three successive Mondays of good news on the vaccine, yet it seems that investors are still short of their targets for risk assets and need to buy as the year end approaches.
Biden and Brexit deal hopes push markets higher
Commentators have ascribed the rally to signs that the US presidential transition was going smoothly, and that Biden has chosen an experienced and technocratic team. But this is hardly surprising, and if the market can move ahead on that news, I’d anticipate a further boost if, as I expect, the UK and EU come up with a deal over Brexit. It’d be a fairly thin deal to be sure, but much better than if it all ended in acrimony. The sticking point has now come down to fish – which was always going to be the final piece of the jigsaw. And the deal will involve a lengthy transition period, to assuage the French, but with a big cut in the EU catch quota in UK waters, to appease the British fishing industry. If I’m wrong and there’s no deal, there’d be a sell off, notably in sterling. But I believe the odds clearly favour a deal.
Dreadful data to come, but light at the end of the tunnel
In other news, we’ve got the prospect of the UK authorising the Pfizer vaccine this week and the AstraZeneca vaccine next week, with a programme to vaccinate the vulnerable, the elderly and key workers before year end. The plan appears to be to give the Pfizer vaccine to the elderly and the AstraZeneca vaccine to the younger groups. The UK lockdown is already beginning to reverse the surge in new cases, and mass testing is set to push it down further.
In general, new cases are falling in Europe but rising in the US. This reflects the easier lockdowns in the US plus the huge impact of Thanksgiving. With Christmas yet to come, we will likely see a further uptick in infections in the US and a renewed rise in Europe. Markets will have some dreadful data to digest in the interim but there is now a bright light at the end of the tunnel in terms of viable vaccines.
What lies ahead for bond markets?
Last week, Portuguese 10-year bond yields traded at a negative level. They are now just above zero. Despite massive fiscal deficits around the world, and confidence in an economic recovery from Covid, bond yields remain extraordinarily low. We are confident that economic recovery will not see a resurgence of inflation and that central banks will keep official rates very low over the next year or more. Yield curves will steepen as the recovery takes hold but probably not by enough to disturb markets. The curves are already pricing in a significant rise in yields – for 10-year US treasuries to rise from the current level of 0.84% to 1.03% a year from now, and for 10-year gilt yields to rise from 0.27% to 0.43%.