US Presidential Election May Spook Volatility

  


S&P 500 FUNDAMENTALFORECAST: BEARISH

  • Volatility may be elevated in view of presidential debates and a pending US fiscal stimulus plan
  • US presidential election, coronavirus resurgence, and rising US Dollar are among the key risks
  • Recent selloff may prove to be another “healthy correction” in the medium-term bull run

S&P 500 Index Outlook:

Since early September, US stock markets entered a consolidative phase, pausing a five-month rally that was mainly driven by recovery hopes and Fed’s balance sheet expansion. With the Fed members warning a lengthy recovery and lacking fiscal stimulus support, equity markets seem to have lost some steam. Unwinding activities were seen in risk assets, whereas safe-haven assets were on bid. The US Dollar Index (DXY) has climbed to a two-month high of 94.4.

Although the central bank has signalled no rate hikes until year 2023 in the latest FOMC meeting, a slowdown in the Fed’s balance sheet expansion and its reluctancy to ease more weighed on market sentiment (chart below).

S&P 500 Index vs. Fed Balance Sheet (2015-2020)

SPX Balance sheet

Some near-term headwinds include the US presidential election, a ‘second wave’ of coronavirus in parts of the EU, and a pending US fiscal stimulus package. The first Trump – Biden presidential debate will be held next week, September 29 from 9:00-10:00 P.M. ET. This debate may draw millions of viewers and market volatility may rise during the debate. The CBOT VIX term structure has likely priced-in higher volatility associated with options on the S&P 500 index leading up to the November election (chart below).

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Besides, credit risks are soaring among China’s property developers, most of which are highly leveraged. Evergrande, one of China’s largest real estate company, has warned of a possible debt restructuring if it doesn’t get an IPO approval by end January. A failure by Evergrande to meet its debt obligations, if happens, will likely bring significant ripple effects to Asian bonds and stocks.

VIX Volatility Index Term Structure– as at 09/24/2020

VIX Term structure

Back to US markets, recent selloff in equities appeared more like a “healthy correction” in a medium-term bull run, because there seems to be lack of systemic risk. The US economy is riding a slow but steady recovery from the Covid-19 pandemic. The unemployment rate has fallen to 8.4% in August from March’s high of 14.7%. Inflation – measured by US core CPI – has climbed to 1.7% in August from April’s low of 1.2%.

The Fed have revised up this year’s median US GDP growth forecast to -3.7% from June’s forecast of -6.5%. Meanwhile, the growth forecasts for year 2021 and 2022 have been slightly revised down to 4.0% and 3.0% respectively.

Economic projection of Fed Board members and Fed Bank presidents, Sep 2020

Fed projections

Source: federalreserve.gov

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— Written by Margaret Yang, Strategist for DailyFX.com

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