US stocks traded weaker overnight with the S&P down a further 0.8% as markets continued to digest the on-hold US Federal Reserve decision.

As central banks shifted from proactive to reactive mode, economic data and market momentum will need to do the heavy lifting, and on that front, it is all about the US election and Covid-19 risk.

With a more limited central bank policy balloon floating markets, the powerful undercurrents from the Covid-19 and the US elections will likely steer the market ship.

The Fed’s communication was not disappointing. It was more a nod to reality. Fed policy inspired risk gains have been well juiced, so it is all down to pure growth.

US election risk

The US election risk, which is more about post-election uncertainty than the actual outcomes, is getting partially priced. There is virtually no expectation for stimulus, just as Trump is now pushing the Republicans to agree to a broader fiscal package (I am sure he is overseeing stocks).

The Nasdaq, which plummeted 12% off its Sept. 2 record in just six days, has recouped some 3% of its loss, Nasdaq volatility has dropped and investors – retail and hedge funds – bought the dip.

Still, they remain scarred, and while relative bargains are to be had, flows are not sponsoring those fire sales as last week’s warning shot on concentration is something investors are not taking lightly.

The tech sector jolt continues to underscore a subtle change to investor behaviour and one that could rear its ugly head again.

A visible view is emerging that with the Fed is out of the way (and potentially running out of bullets), recovery slows. And as the cost of protection to hedge against US election risk rises, investors will need to de-risk their crowded positions to protect overall portfolio performance.

Fed Post Mortem

The Fed was a disappointment but not a game changer – rates are lower bound for the long haul, and the Fed put is alive and well with a commitment to use the full range of tools if necessary.

Forex markets

As much as Interbank pros would love to squeeze the EURUSD longs, they are finding it hard to look past US dollar weakness from a central bank that will allow inflation to run ‘hot,’ as the labour market heals against the backdrop of a large external deficit.

But it was Yuan-centric currencies that were the anti-dollar driving force in the market post FOMC. The dollar downside in North Asian currencies remain firm – USDCNH, USDKRW, and USDTWD their fundamentals intact, given increasing China trade surplus and tech export recovery for Korea and Taiwan.

The ringgit has held on to recent gains and traded at a seven-month high at one point this week. With the Fed risk out of the way and with the MYR still cheap relative to the regional basket and oil prices stabilising higher again, the ringgit should continue to get stronger provided China recovery remains Covid-19 free.

Malaysia’s exports to China will most certainly continue to improve with mainland retail consumption demand catching up to the China industrial engines firing on all cylinders.

US dollar still in consolidation mode

After a short-lived attempt to make new lows in August, the dollar has entered into a prolonged period of consolidation. While the linchpin of dollar bearishness is evident for all to see due to fiscal and monetary led currency debasement alongside Chinese growth, the short-term prospects are still mixed.

There is a lack of clear-cut catalysts until perhaps vaccine results closer to month-end. And by then, the reaction could be muddled as we head into a month of US election uncertainty.

European asset allocation story has been a flop, first by growth – German growth is still strong and will continue to improve given its exposure to China. But the rest of Europe is struggling to battle the rise in COVID-19 cases. And now, the overhang of UK politics could provide the darkest cloud of all.

As a result, the path of least resistance for the dollar has shifted towards China. Like past global growth slowdowns, the Mainland’s ability to generate a credit on the spot has led to the most enduring post-COVID-19 recovery.

While most Asian economies also do not have to deal with a new rise in COVID-19 cases, it is notable that despite the recent weakness in equities, China demand proxies like copper and iron ore have gone moonshot and so has Asia FX with USDCNH making new cycle lows. And this has led to the AUDUSD outperformance.

Japanese yen gains strength

Lastly, USDJPY has piqued the market’s interest again the moment it traded below recent lows.

Japanese PM Abe’s decision to stand down represents the end of an era. Using flow dynamics and accounting for real rate differentials, the yen screams as much as 15-20% % too cheap.

The new PM will face a more challenging environment where all the easy policy options have been tried, his authority is more limited, and for the first time in a decade, JPY outflows are reversing as FDI outflows drop sharply in a lagged response to corporate profits plummeting and supply chains being internalised.

The long JPY trade has little to do with Fed policy but has much to do with the shifting tides of real money flows.

Yen’s strength seems the most likely outcome of PM Abe’s early resignation. His surprise departure due to poor health marks the end of a period of innovation. And with Japan’s retail investors set to bring their money back into Japan, there is scope for significant yen gains.

Gold remains in no-man’s land

Gold remains mired in no man’s land as gold investors stay in stasis, questioning the Fed’s ability to generate inflation rather than its resolve to hold rates down.

Even though interest to buy gold has faded a lot, gold seems to have set a temporary bottom. At the same time, investors like gold because the FOMC’s new policy roadmap solidified expectations that rates will stay low for a long time.

Still, the elusive catalyst that takes the yellow metal above $2000 remains the big mystery, and the indecisive price action is telling.

With nary a rise from inflation break-evens, the longer we consolidate and as positive vaccine news trickling in, the greater the risk for gold prices to move lower.

International markets analysis and insights from Stephen Innes, Chief Global Market Strategist at AxiCorp