Standpat FOMC Trumped by US Political Jitters

Election Day 2014 - Republicans and Democrats in the campaign

  • The single biggest driver in the capital markets is the continued narrowing of the US election polls
  • The eurozone manufacturing PMI was reported a little above the flash reading (53.5 vs. 53.3)
  • The UK reported a stronger than expected construction PMI
  • There are two events in North America that may briefly command attention over the politics: ADP and FOMC
  • Politics are heating up in South Africa and Korea
  • It’s worth noting that today is a holiday in Mexico, so markets are testing Banco de Mexico

The dollar is broadly weaker against the majors. The Kiwi and the yen are outperforming, while the Aussie and the Loonie are underperforming. EM currencies are mostly weaker as risk off takes hold. ZAR is outperforming after South African President Zuma dropped his bid to block the release of a potentially damaging graft report, while MXN and KRW are underperforming. MSCI Asia Pacific was down 1.1%, with the Nikkei falling 1.8%. MSCI EM is down 1%, with Chinese markets falling 0.8%. Euro Stoxx 600 is down 0.6% near midday, while S&P futures are pointing to a lower open. The 10-year UST yield is down 3 bp at 1.80%. Commodity prices are mostly lower, with oil down 1.5%, copper down 0.9%, and gold up 0.7%.

The single biggest driver in the capital markets is the continued narrowing of the US election polls. The prospect of a Trump presidency and the dramatic changes that it could entail is rattling investors and spurring position squaring. The dollar is broadly lower as are stocks. The surge in global yields has been arrested.

Even before the FBI announced a re-opening of the investigation into Clinton’s emails, Trump has been recovering from the deep hole dug in recent weeks. However, over the past five days or so, he has recovered further, and the much-watched fivethirtyeight.com has tracked a 10 percentage point decline in the likelihood of a Clinton victory to just below 72% now. Another poll tracker and analysis site, Predictwise, puts the odds at 84%, down from 90% over the past two weeks.

There are two important considerations that will keep investors on edge. First, the odds have yet to bottom. The swing in opinion is a gradual process, and the momentum still is building. Second, time is of the essence. The election is a week away. However, there is a significant mitigating factor. The US president is not picked by popular vote but by an electoral college. Here the projections are not as close as some of the national polls suggest. Most calculations still see Clinton securing 303 electoral college votes, while 270 are needed.

The dollar is weaker against most of the major and emerging market currencies. Among the majors, the exception is the Australian dollar that has been dragged down by the unexpectedly sharp drop in September building approvals (-8.7%, more than twice the expected decline). Between this decline and August’s (-1.8%), July’s heady 11.5% gain has been retraced.

The Russian ruble and Malaysian ringgit are under pressure, apparently dragged down by the drop in oil prices. Oil prices have been sliding since early-October, but today’s losses have been encouraged by the large (~9.3 mln barrel) jump in US oil inventories, according to API. The DOE estimate is due out later today and is regarded as a more robust figure.

The eurozone manufacturing PMI was reported a little above the flash reading (53.5 vs. 53.3). This is the best since January 2014. The improvement was due to France and Spain. France’s PMI rose to 51.8 from the flash estimate of 51.3. Spain’s rose to 53.3 from 52.3 in September. For its part, the German reading came in a tough softer at 55.0 from 55.1, and Italy disappointed by slipping to 50.9 from 51.0 in September.

The UK reported a stronger than expected construction PMI. The 52.6 reading represents a small improvement over September’s 52.3 and is the best since March. The median expectation was for a small decline. The Bank of England meets tomorrow. Reports today have NIESR forecasting steady rates now until H2 19, which perhaps not coincidentally may coincide with the end of Carney’s tenure.

The euro has extended its recovery to $1.11 and is up almost 0.9% this week. The 5-day average is crossing above the 20-day average for the first time in a month. The old trendline drawn off the January, June, and July lows comes in near $1.1070. The euro broke below near-mid-October and now has resurfaced it. The next technical objective is found near $1.1115 and then $1.12.

The dollar has been trying to establish a foothold above JPY105 for the last four sessions. The US political jitters and softer US rates have pulled the greenback toward JPY103.50 now. We see the next support near JPY103.20 and then JPY102.80.

Sterling is trading higher for the fourth consecutive session. It has edged above last week’s high (~$1.2272) but has not been able to poke through $1.2300. If it does, which the intraday technicals suggest is possible, we see the $1.2325-$1.2350 area as a likely cap.

Equities are under pressure after yesterday’s slide in the US. The MSCI Asia-Pacific Index fell a little more than 1%, its largest drop in more than a month. The Nikkei gapped lower after reaching six-month highs yesterday. European shares are extended their losing streak. The Dow Jones Stoxx 600 is off for the eighth consecutive session, the longest slide in at least five years. Like the Nikkei, the DAX and CAC gapped lower at the open today.

Benchmark yields are broadly lower today. Europe is seeing a 5-9 bp decline in 10-year yields, with the periphery outpacing the core. US 10-year yields are off 4 bp to slip below 1.80% for the first time in a week.

There are two events in North America that may briefly command attention over the politics today. The first is the ADP private sector employment report. A small improvement is anticipated. Expectations for Fed policy may be impacted by the electoral outcome. If a Trump victory leads to a dramatic market reaction, as if what is happening now is a small pre-taste of what could happen, this may become a factor in the Fed’s contemplation in December.

The second event is the FOMC meeting. Barring a surprise, it should pose only a little headline risk on the announcement. No one expects a change in policy today. There is a long tradition of expressing its apolitical stance by not grabbing headlines from the election. There is simply no precedent for change policy this close to a national election. Moreover, there is not the urgency to demands overcoming the inertia of tradition and the logistical challenge of not having a scheduled press conference.

Last October, the FOMC clearly pre-committed to a December hike. While we expect some minor tweaks in the FOMC statement, we do not expect such an explicit commitment. If it does materialize, though, it could allow one or more voting members to drop their dissent.

Politics are heating up in South Africa.   The rand gained today on reports that President Zuma dropped his bid to prevent publication of a potentially harmful investigative report on the Gupta family’s influence on his government. Protests against corruption were held today in Pretoria, while a major union (and ANC ally) called on Zuma to step down. So too have some major business leaders. While Zuma has survived numerous scandals already, local political analysts believe that this time is different.

Korean politics are also heating up. President Park replaced her Premier and Finance Minister in a bid to limit the fall-out from an influence peddling scandal. We doubt the shuffle (pending parliamentary approval) will do much to help her popularity, and pressure is building for her to step down. The won has been underperforming. For USD/KRW, a clean break above the 1151 area would set up a test of the post-Brexit high near 1188 from June 27.

It’s worth noting that today is a holiday in Mexico. The last holiday was on September 16. We remember that day well, as markets pushed USD/MXN higher to test the central bank’s resolve. The pair rose 1.4% that day as Banco de Mexico did not intervene, and then went on to make a new all-time high near 19.93 on September 27. Markets are testing Banco de Mexico again today, with the peso down almost 1% already on US election jitters. For USD/MXN, the move above 19.1840 filled the gap that was created on October 10. Break above 19.37 sets up a test of that all-time high.