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Allianz Investment Management LLC October Market Update

Each month, representatives from Allianz Investment Management LLC provide commentary on market and economic indicators, including Federal Reserve actions, interest rates, credit markets and economic releases such as inflation, GDP, consumer confidence, housing, retail sales and job unemployment news.

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Market Outlook: More stimulus is likely needed to keep the economic recovery firing on all cylinders


The speed of the recovery is being called into question by market participants as prior fiscal stimulus measures continue to fade and the motivation for Congress to pass a fresh round of fiscal support for the economy is becoming more stale by the day. While most economic data in recent weeks have been generally positive, one area of concern has been the labor market. In particular, the bifurcated recovery in the economy has left some sectors hit hard by the pandemic continuing to struggle. The decelerating pace of job growth is becoming concerning, as only about half the jobs lost since the lockdown have come back. The main risk to the economy is that generally, the longer people remain unemployed, the more difficult it becomes to find a job as skills begin to erode. Additionally, the Fed has been very explicit in the need for Congress to act and provide additional spending measures, but bi-partisan politics have kept a comprehensive relief package from making it to the finish line. Overall, we do expect the economic recovery to continue, but without the support on the fiscal side, expectations will need to be tempered, as uncertainties including the effectiveness of a vaccine will weigh on the economy in the months to come.



Risk-free rates continue to remain range bound as investors consider upcoming risks around the U.S. election and the potential for an effective vaccine. Additionally, the Fed will continue to keep a lid on how far rates can rise as they maintain their bond buying program. The last thing the Fed wants is another “taper tantrum” where, back in 2013, the 10-year Treasury yield rose over 100 basis points in a matter of months as the Fed signaled a slowdown in bond purchases. However, regarding the shape of the yield curve, we could expect to see more bear-steepening in the near term if additional fiscal spending occurs and inflation continues to increase faster than expectations. It is entirely plausible that we could see a 10-year Treasury yield near one percent after election uncertainties have passed and positive progress towards a vaccine continues. On balance, we recognize there are still some risks on the horizon, but the bias is tilting slightly toward higher rates over the medium term.


The U.S. election and what to expect

Elections can get messy, and given the pandemic will likely alter how the results are received with an increase of mail-in ballots, we expect there will be some increased uncertainty around the outcome of the U.S. election. Therefore, we expect markets to maintain an elevated level of volatility leading up to, and possibly beyond, the November 3 election day. It’s not so much about who gets elected, but more so how we get there. A contended election by either party is very undesirable from a market perspective, as this will only lead to greater uncertainty and more volatility. The last time there was a contended election was in the year 2000 (Bush vs. Gore) and equity markets sold off and credit spreads widened as a result. At a high level, there can only really be two scenarios: a divided government in which no single party controls both the legislative and the executive branches of government or a unified government where one party controls both branches of government. A unified government has the ability to enact greater policy change, but with the margin of difference in party lines likely to be small, the probability for meaningful policy change is minimal. Markets, for the most part, have put a higher probability on this year’s election delivering a divided government, which means the tail-risk scenario is really about how contentious the results end up being.

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Focusing on downside risks, the Federal Reserve is making the plea for addition fiscal stimulus

The Fed acknowledged the economy has recovered faster than they initially expected as they revised their economic projections upward. However, the gloom and doom train hasn’t left the station for the Fed, as Chairman Powell continues to beat the drum for additional fiscal stimulus to Congress. Downside risks from the Fed’s view continue to be centered on the path of the virus and the ability of the economy to regain the jobs lost from the pandemic. The Fed is particularly worried about sectors in the economy that have been slow to rebound in recent months. Without additional support, business bankruptcies could begin to weigh on future economic growth. On several occasions, Chairman Powell has pleaded to Congress the need for additional fiscal stimulus measures as the economic recovery has a ways to go. Even within the minutes of the September Fed meeting, Fed officials agreed, “the pace of the economic recovery would likely be slower” without further policy support. For now it appears that discussions in Congress over fiscal stimulus have been tabled, but investors continue to factor in that stimulus is coming even if it is after the election.


Market indicators

Market participants are expecting elevated volatility leading up to and beyond the election

Broad stock indices took a hit last month as investors weighed the upcoming election risks against lofty valuations. The S&P 500 Index still remains in positive territory for the year, but it appears that some chips were taken off the table over the past month. For instance, the strongest performing sectors since the pandemic, like technology, took the brunt of the selloff. We are less than 60 days until the election and the current backdrop is setting up for a volatile market event. A contentious U.S. election is sure to bring on a wave of volatility as investors grapple with uncertain outcomes in an already jittery market environment.


After spiking to a high of 38.28 in early September, the Cboe Volatility Index (VIX) settled down in the mid-twenties by month's end. Much of the increased volatility last month was a result of lofty valuations in technology stocks that caused investors to de-risk. Looking ahead, the market is expecting elevated volatility beyond the election as VIX futures for November, which represent 30-day forward expected volatility, are priced higher than the following month contracts. Time will tell if expected volatility turns into realized market volatility, but for now the market is bracing for the period leading up to and beyond the election to experience some market turbulence.


Despite being near the top end of their recent trading range, Treasury yields continue to be anchored by Fed purchases and investors posturing for economic uncertainty in the coming months. The correction in equities throughout September spurred a risk-off tone in the market that kept Treasury yields fairly steady throughout the month. Additionally, the upcoming election will likely steer nervous investors towards safe-haven assets like U.S. Treasuries. Beyond the immediate uncertainties on the horizon, we see a plausible path for rising interest rates as the macro backdrop continues to improve and the hunt for an effective COVID-19 vaccine continues.


With the macro backdrop slowly improving and the supply dynamics in oil markets stabilizing further, the momentum for West Texas Intermediate (WTI) crude oil prices remains upward. However, we still remain cautious at current levels as demand is still well below pre-pandemic levels. Significant drivers of demand, particularly the airline industry, are still struggling with the aftermath of the virus and until we have effective vaccines, it would be difficult to see a significant jump in energy prices from current levels.


Economic indicators

The decelerating pace of hiring signals the economic recovery may be slowing

The ISM manufacturing index came in at 55.4, slightly below expectations of 56.5 and August’s reading of 56.0. The decline was driven by a drop in the new orders index, which settled at a more sustainable level at 60.2 from August’s reading of 67.6. With manufacturing output still 6% below its February level, there is plenty of room for rapid growth over the coming months, as production catches up with the much faster rebound in goods consumption. It is worth noting that the shortfall in inventories, which are at their lowest level since June 2010, is putting upward pressure on prices.


The expiry of the enhanced unemployment benefits at the start of August did not have as catastrophic of an impact on spending predicted by some analysts. While August retail sales figures underperformed expectations, they still rose 0.6% in August vs. the 1.0% expected. Consumer spending was positive in 7 out of 13 categories, and food services sales saw the strongest rise at 4.7% due to declining virus numbers allowing more bars and restaurants to reopen. Retail sales now stand $10.3 billion (1.9%) above its pre-pandemic level in February 2020. However, in the absence of further fiscal support, we expect consumption to inevitably slow.


A weaker than expected employment report in September suggests that the rebound we have witnessed may be slowing down. Non-farm payrolls only increased by 661k, which was disappointing versus survey estimates of 859k payroll additions. Average hourly earnings increased 0.1% from August versus estimates of 0.2%. The unemployment rate fell to 7.9%, however the labor force participation rate also declined. Since the pandemic started, just over 50% of the jobs lost have been recovered. This will become more concerning to the overall health of the economy the longer it takes to bring those jobs back. Overall, September’s employment report, combined with ongoing virus concerns, should signal to political leaders that the fragile recovery requires additional stimulus as a means to support the labor market.

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To sum up, many market participants, including the Fed, have acknowledged the slowing pace of the economic recovery, and the need to add more fuel to the economic recovery in the form of fiscal spending, grows by the day.  Unfortunately, politics have created a near-term hurdle in moving a fiscal stimulus package across the finish line. Overall, we expect market volatility will remain elevated in the coming months as investors position for the upcoming U.S. election, the potential for effective vaccines, and additional government spending.


List of definitions

Here are the definitions of the key terms used in this market report.

The views expressed above reflect the views of Allianz Investment Management LLC as of 10/2020. These views may change as the market or other conditions change. This report is not intended and should not be used to provide financial advice and does not address or account for an individual's circumstances. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Allianz Investment Management LLC is a registered investment adviser that is a wholly owned subsidiary of Allianz Life Insurance Company of North America.