The adverse market environment persisted last week. COVID-19 cases in Europe are still increasing (implying more restrictions), while infection numbers in the US are not declining as fast as hoped (see COVID-19 Update – Brace yourself; winter (and tighter restrictions) is coming, 24 September). The Fed remains (at least at the moment) unwilling to ease monetary policy further and the prospects for support from the fiscal side are also fading fast. The mix weighed again on equity markets, with Europe outperforming, underlined by the rotation out of US tech. EUR/USD broke below 1.17, weighed down by the resurging uncertainty of lockdowns in Europe and the downward pressure on global yields continued.

One notable exception was Italy, which saw its 30Y government bond yield touch a record low of 1.75%, after the governing coalition fended off a challenge by Matteo Salvini’s right-wing populist League party at regional elections. As right-wing momentum continues to ebb and the governing coalition has been credited with handling the coronavirus crisis fairly well, the risk of Italian snap elections has decreased significantly, probably delaying a vote until at least early 2022. That said, we expect markets to keep a close eye on how Italy plans to use the EU money to kick-start its economy and we expect the release of a 2021 budget draft in the coming week. Germany was a bit quicker and unveiled its 2021 fiscal plans last week, which assume continued new borrowing until 2024 and thereby no return yet to the balanced budget policy from pre-coronavirus times.

September PMIs showed a mixed picture in Europe, with the manufacturing sector still in the driving seat of the recovery, while services PMI fell back into contraction territory for the first time since June. While the lost momentum in domestic demand is worrying, forward-looking subcomponents such as expectations and employment plans held up, suggesting that service providers still perceive the recent headwinds as temporary. We received a similar message from EU households last week, as consumer confidence improved despite the recent infection outbursts.

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Across the Atlantic, PMIs held up better than their European counterparts, remaining comfortably in expansion territory, with the US infection peak in August. Also on a positive note, the US House managed to pass a stop-gap funding bill and thus avert a government shutdown until 11 December. That said, the US Supreme Court judge fight continues and while President Donald Trump has said he will name the successor to Ruth Bader Ginsburg on Saturday, it does seem to complicate the negotiations over another fiscal relief package.

Apart from US politics, Fed minutes/speeches and the last Brexit negotiation round ahead of the important EU summit on 15-16 October, next week also brings a string of important macro data. US private spending data for August will be in focus after the weak retail sales print and the September US jobs report on Friday is likely to see a continuation of the positive employment trend of +1m. Markets are also set to keep an eye on Chinese PMIs out on Wednesday morning, for a clue about where the global recovery is heading. In Europe, the highlights of the week are the September HICP figures on Friday, which we expect to show a small rebound in core inflation from the August plunge, and the ECB Watchers Conference, where a range of Governing Council members will be on the wires with comments that could move markets.

Full report in PDF.

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