Biden's exit: Markets still digesting departure
World markets steadied on Tuesday as investors shifted their attention to corporate earnings and economic data, following Joe Biden's exit from the U.S. presidential race.
Biden's withdrawal has created uncertainty around a Republican victory under Donald Trump, potentially affecting trades that bet on increased U.S. fiscal and inflationary pressures. Vice President Kamala Harris is set to campaign in Wisconsin on Tuesday as the Democrats' presumed nominee.
Biden exit reaction is complex
The path ahead for the Democratic ticket remains uncertain,
but Vice President Kamala Harris remains the presumptive nominee unless negated
by events. The biggest impact reaction for Treasuries was a late-in-the-day
rise in yields, coinciding with a tech-heavy risk-on theme. The front end of
the curve has taken a mild hit too, pulling lower the probability of a rate cut
in September. A September rate cut is still practically discounted, but an
element of doubt has been introduced as some believe the Fed might prefer not to
add to the rise in volatility seen in the past few weeks. We don't find much
substance to this notion.
Also, risk has been on since November 2023
and is arguably vulnerable to coming off. The announcement that Biden will not
run would seem to end uncertainty, but it can also create doubts for
risk-takers. A vacuum like this would be as good an excuse as any for risk to
come off, and if that happens, US Treasuries are likely to rally, and yields
will fall. That would be sustained by a lesser 'growth oomph discount' as
the probability of a Trump victory is downsized – but not by much, as a
Trump victory remains broadly discounted.
These are fine margins, and hence,
elevation in volatility has been the most sensible outcome.
Biden’s withdrawal did not have a material impact on EUR
rates. The 10Y Bund yield is 2.5%, a level it has been trading around
since March. The short end has come down a bit since peaking in June, mostly
driven by Fed expectations, but also with more ECB cuts in sight. So far
economic data has shown modest resilience, yet this week’s PMIs could be
foreboding if the downticks from last month turn out to be the start of a
broader weakening. In that case, EUR curves could see more steepening after
having lagged the US.
On Monday, the European Central
Bank published the outcome of July’s Survey of Monetary Analysts,
which has shown an expected terminal ECB rate of 2.25% in all surveys this
year. Markets’ outlook based on the ESTR 3Y1M forward shows a convergence to that
level since April. As Fed and ECB cuts start materialising, we expect yields to
go lower, but a well-anchored terminal ECB rate means that the scope for lower
rates could be limited in the eurozone.
Michael Brown, senior strategist at Pepperstone in London,
noted that markets are in a "holding pattern" after digesting Biden's
news. Investors will now monitor polls to see if the race against Trump
tightens, potentially increasing volatility and impacting equity markets.
Data Watch
In currency markets, the yen gained 0.7 per cent against the
dollar, influenced by comments from a senior Japanese politician urging the
Bank of Japan to continue hiking rates to strengthen the currency. China's
recent interest rate cuts highlighted the economic weakness, affecting markets
with Chinese stocks seeing their largest single-day drop in six months, copper
prices hitting a 3.5-month low, and declines in the Australian and New Zealand
dollars.
The euro fell 0.3 per cent to $1.086. Central bank actions
remain a key focus, with markets anticipating two U.S. rate cuts this year,
possibly starting in September, though growth and consumer price data due later
in the week could alter expectations.
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