Deriv Quarterly Intelligence Report -- Will the Financial Markets End 2020 with a Bang?

We’re already into the last quarter of the year and the excitement is nowhere near abating. 2020 has been a year like no other. While it started out with the UK finally leaving the EU, the markets were taken totally unawares by the COVID-19 pandemic. The huge stock market crash of March sent investors reeling and coronavirus news overshadowed most other factors that usually move the markets through the year. So much so that traditional safe haven investments like the US dollar and oil lost their sheen for investors.

So, will Q4 be any different? No, excitement levels are only rising, with the US Presidential Election just around the corner, the October 15 Brexit negotiation deadline having been missed and the pandemic continuing to rage on. So, tighten your seat belt and check out what lies in store this quarter.

A Mexican Standoff in Europe

Boris Johnson’s October 15 deadline, for the finalisation of the Brexit trade deal, came and went. The UK stated that there was no point in resuming talks unless there was a “fundamental change” in the EU’s approach.

So, both parties are now urging each other to make the first move. At stake is billions of pounds worth of trade, which would be in danger once the UK’s status quo with the EU ends on January 1, 2021. The problem is that the 5-year-long Brexit drama has already disrupted most sectors of the UK economy, from agriculture to manufacturing and retail. On top of that came the COVID-19 pandemic, which almost brought the economy to its knees.

Prime Minister Johnson still maintains that the nation should prepare for a No-Deal Brexit on January 1, although some senior ministers, like Michael Gove, have expressed more conciliatory intentions. We’ll have to now wait and see what transpires during the telephone call to be held between the EU’s chief negotiator, Michel Barnier, and David Frost, his British counterpart. Some of the issues that still need to be resolved include the rules for dispute resolution, fair competition and fisheries.

Impact on the Great British Pound

Surprisingly, the Pound Sterling found sufficient support, even as Boris Johnson decided to forego his own deadline. Investors seem hopeful that the door has been left open for the EU for further talks. With the market continuing to believe that a trade deal might still be struck before the year end, the GBP/USD has held around the 1.29 mark, as of October 21, 2020. The GBP/EUR rate has also remained steady.

The overall market sentiment is that even if the EU does not give in to the UK’s demands, Prime Minister Johnson will move forward with concessions to ensure the welfare of the nation. However, analysts believe that the Pound Sterling is unlikely to remain rangebound for too long.

The Stock Market Impact

The stock market story has been different. UK shares dipped, taking the FTSE 100 index down, due to the uncertainty created by the missed Brexit deadline. However, the market has turned more optimistic since then, expecting the EU and UK to eventually strike a deal. Of course, many believe that with both parties angling for the best terms, the talks might go right up to the proverbial eleventh hour, December 31.

Even if a trade deal is agreed upon, the UK will need a period of adjustment, during which economic growth could be muted. This is because the ongoing pandemic has already weakened the UK economy significantly.

The good news is that UK stocks have risen since their initial reaction to the missed deadline, with the [FTSE 100] rising 0.1% and FTSE 250 up 0.4%, on October 20, 2020. Analysts believe that hopes of a trade deal by the year-end are responsible for these gains, although the gains were muted by concerns regarding another pandemic-led national lockdown.

A Historically Polarising Election

The final lap of the race to the White House will see huge volatility across the financial markets. What many have called the “most polarising” presidential election in the United States is already breaking records. Close to 30 million Americans have already cast their vote for the 2020 US election.

As November 3 draws closer, investors have been flocking to safe havens, such as gold and Bitcoin, in anticipation of market volatility. In fact, 2020 has positioned Bitcoin as a safe haven, with traditional safe haven investments, like the US dollar and oil, weakening dramatically. Although the presidential candidates, Trump and Biden, have been mostly impartial towards cryptocurrencies, the focus on global Central Bank Digital Currencies (CBDCs) and institutional investment might force the next US president to take a stronger stand on digital currencies.

US Election and the Forex Market

Traders are already bracing for US dollar volatility in the lead up to the election and the weeks following the announcement of the winner. Historically, the USD has strengthened post-election, regardless of whether the election was won by a Republican or a Democrat. Historical price data shows that a Democrat win has been followed by an average 4% rise in the US dollar, while a Republican win has been followed by a 2% rise, on average.

However, 2020 has seen unique circumstances with the pandemic and there are sufficient factors to keep the US dollar muted in the medium term. In fact, some analysts believe that the greenback could see downward pressure going into 2021 as well. In addition, some forex analysts have predicted that that a Biden win could lead the US dollar to depreciate, since he is likely to undo many of Trump’s initiatives to bolster the dollar, such as the influence of the White House on the US Fed, loosening of regulations related to the energy and financial sectors and a protectionist trade policy.

On the other hand, if Donald Trump wins the election, there could be a second tax cut and further fiscal expansion, which would be good news for cyclical markets, such as Japan. This means that the Japanese yen would gain support. On the other hand, a Trump win would put pressure on the performance of the Chinese yuan, while trade tensions could escalate between the US and China. Another term for Trump could also lead to short term appreciation in the USD, with renewed concerns of trade tensions adding to the dollar demand.

How Will the Stock Market Fare?

The global stock markets have usually done well, regardless of the outcome of the US presidential election. The only exception was 2008, when the markets were already burdened by the subprime crisis. So, analysts believe that stocks might soar regardless of whether Trump or Biden wins.

The US stock markets have been on a growth path since the March lows, supported by the US Fed and government efforts, such as the huge stimulus push. In the run up to November 3, Trump and Biden seem to be engaged in a stimulus battle, with each trying to outdo the other, promising larger and larger packages. This stimulus race will also bolster the equity markets.

Analysts believe that a Trump win would be more positive for US stocks than a Biden win, given his pro-business approach. On the other hand, a Biden win could prove positive for Asian stocks, especially China, if the Department of Commerce allows Huawei to sell chips once again. On the whole, regions exposed to global trade and stock markets are likely to do better under a Biden presidency. Biden has also stated that he would lift the current suspension on H-1B visas, which could prove positive for the IT sector.

So, volatility is likely to mark Q4 2020, maybe even more so than the rest of the year. Now, if a coronavirus vaccine is also approved in the quarter, we could be in for a real roller coaster ride.

An action packed and volatile quarter means opportunity for forex, commodities and stock indices traders. Tweet us @Derivdotcom and tell us what you’re trading.