No Real Direction

Ahead of the midterm election
The dollar’s had no real direction
Once ballots are tallied
The dollar, which rallied
Before, may be due for rejection

It’s Election Day here in the US, as I’m sure everyone is already aware. The current expectations are for the Democrats to capture the House while the Republicans maintain the Senate, with perhaps a larger majority. Of course, many of you may remember the 2016 Presidential election when expectations proved misguided. My point is, nothing is clear to me at this point, and I will not pontificate on any particular outcome. Rather the question at hand is, what will happen to the dollar once the ballots are counted.

If expectations are borne out, a gridlocked government is likely to put forth significantly less in the way of economic policy initiatives. Given the lack of fiscal policy changes, monetary policy will gain in importance. If there is no additional fiscal stimulus, will the Fed feel compelled to continue tightening as quickly as they have been doing? Will the US economy slow more rapidly than currently projected (remember we are already growing well above most economists’ forecasts for sustainability which hover between 2.0% and 2.5%)? If this is the case, then it would be reasonable to expect the dollar to soften going forward since right now, the dollar’s strength can be largely attributed to a Fed that is tightening faster than most of the market had assumed would be the case.

On the other hand, either of the other two scenarios, the Democrats sweep or the Republicans sweep have much clearer implications for the dollar, at least to my mind. In the event of the former, I would expect the dollar to come under immediate pressure. The probability of impeachment proceedings would rise significantly and with that, the chaos that would occur would almost certainly undermine the dollar. One need only look back twenty years, when a Republican House of Representatives sought to impeach Bill Clinton. From September 1998 through the actual vote in December 1998, the dollar declined roughly 10%. Something like that is entirely realistic.

And if the Republicans were to hold the House and grow their Senate majority, the probability of even more fiscal stimulus would simply force the Fed’s hand further, and may see an even tighter policy response, as their fear of inflation would grow commensurately. A more hawkish Fed, especially in the context of what is a clearly slowing global economic picture, should further support the dollar, with a move toward 1.05 in the euro very viable. Not tomorrow mind you, but over time.

At any rate, for today, there is very little else we can do than wait. So looking at the rest of the world, we see that growth in the Eurozone may not have been quite as bad as feared. The flash PMI numbers reported two weeks ago were worse than the finalized ones reported this morning, but they are still the softest readings in more than two years. Yesterday saw the euro edge slightly higher by the end of the day, but in reality, it has done virtually nothing since November 1st. This is the picture of a market biding its time, with the election clearly the event of note.

Meanwhile, the pound continues to creep higher as there seems to be a growing belief that PM May will be able to convince her cabinet to support her with regard to the Brexit deal she is proposing. Having read about the proposed solution, it appears to me that pro-Brexit cabinet members will have a difficult time supporting anything that allows the EU to have a role in future UK decisions. After all, the idea behind Brexit was to end that process. But politics makes strange bedfellows, as they say, and so I wouldn’t rule out anything. In the end, the pound remains hostage to the Brexit outcome, and nothing has changed in that regard overnight.

As to the rest of the G10, we have seen a mixed picture with AUD and NZD both having a nice day (both higher by ~0.3%) on the back of the RBA’s upgraded forecast for economic growth Down Under. Just like in the US, wages continue to lag what historic models would indicate, but the RBA is further behind the cycle than the US, and so expectations are growing that the next move there will be for higher interest rates. At the same time, CAD and the Skandies have softened a bit this morning, but in reality, overall movement has been modest at best.

In the EMG bloc, the dollar is actually rising pretty uniformly, with ZAR (-0.65%), MXN (-0.25%), KRW (-0.25%) and TRY (-0.9%) leading the way. CNY has edged slightly lower but remains well within recent trading bounds. The exception to the rule is IDR, which has rallied 1.2% after data showed that foreign inflows into both the stock and government bond market had increased significantly in the past several weeks, prompted by an economy growing more than 5.0% with inflation remaining moderate around 3.0%. And remember, the rupiah had fallen as much as 12% from the beginning of the year before the recent little rally, so many investors see a real opportunity.

And that is really all there is. Both equity and bond markets are biding their time as well, as everybody awaits the outcome of the US elections. There is no reason to believe that the market will move much ahead of that outcome this evening, so hedgers might want to take advantage of quiet markets to top up hedges in the event of a surprise tonight.

Good luck
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