Elections are out of the way
The outcome caused little dismay
Investors seem sure
Good times will endure
With stocks set to rally today

The dollar, however, is weak
Some pundits claim we’ve seen the peak
Still folks at the Fed
See rate hikes ahead
Which could, on those views, havoc wreak

The midterm elections are now past, with expectations largely fulfilled. The Democrats will run the House, while the Senate’s Republican majority has actually grown by four seats to a 53-47 count. At least that’s what appears to be the case at this time, although there are some runoff elections that need yet to be completed in the next weeks. The traditional view of a political split is that gridlock will ensue and very little in the way of new policy will come out of the next Congress. However, in this case, things may not actually work out that way. Consider the fact that President Trump’s populist leanings may well dovetail with Democratic priorities, especially on spending. It wouldn’t be that surprising if the next budget is even more stimulative than the last, especially as by next summer it is highly likely that the US growth impulse will be slowing down somewhat as the effects of the last stimulus fade away. And through it all, there is no indication that the Fed is going to stop raising interest rates, so I might argue that things haven’t changed all that much.

The risks to this view are if the new Democratic majority in the House chooses to use their power to rehash the battles from 2016 or, more disconcertingly for markets, decide that they want to proceed with an Impeachment process against the President. Two things about this issue are that, first, with the Republicans in control of the Senate, there is essentially zero probability that the President would be removed from office, so it would all be for show. But second, as I mentioned yesterday, the last time we saw this movie, in the autumn of 1998, the dollar fell sharply during the proceedings. This is just something to keep in mind as headlines start to flow going forward.

Enough about the elections. The market response overnight showed equity markets feeling a little better, with Europe higher and US futures pointing in the same direction, although APAC markets were largely flat. Meanwhile, the dollar has come under pressure across the board. The latter seems a little counterintuitive, although I guess it is simply a result of the embrasure of risk by investors. There is no need to flock to dollars, or yen for that matter, if expectations turn positive. And that’s what we seem to have seen.

Focusing on the FX market, the dollar is down pretty sharply across the board. Both the euro and the pound are higher by more than 0.5% despite what I would argue was some mildly negative news. In the Eurozone, while German IP was a touch firmer than expected at +0.2%, Retail Sales data throughout the Eurozone was actually quite weak, with both Italian and Austrian data showing contraction while the French managed to just hold on to an unchanged result, and all three coming well short of expectations.

Meanwhile, the pound continues to trade on hopes that a Brexit breakthrough is coming, despite the fact that yesterday’s widely publicized cabinet meeting produced exactly nothing. PM May has two potential problems here; first is the question of actually coming up with a deal that her cabinet can agree to support that also has EU support, a task that has thus far been out of reach. Second, remember that May has a coalition partner, not a majority in Parliament, and the Labor Party is now coming on record that they will vote against any deal. If that is the case, it is entirely possible that it all falls apart and the UK leaves the EU with no deal in place. While the pound has rallied nicely over the past week, up more than 3.5%, I continue to see the downside risks being significantly greater than the upside. Certainly the rally on a deal announcement would be much smaller in magnitude than the decline in the event of a hard Brexit. Hedgers must keep this in mind as they manage their risks.

As to the rest of the G10, the dollar has fallen even further than the euro and pound, with 0.7% pretty common across virtually the entire bloc. The only two exceptions are JPY, with a more modest 0.3% rally and CAD with a similar gain. My sense is the former is all about risk reduction mitigating some of the dollar weakness, while the latter is related to the fact that oil prices continue to fall, having come down nearly 20% from their highs reached in early October.

In the EMG bloc, there is broad dollar weakness as well with IDR leading the way (+1.5%) and ZAR jumping a solid 1.25%. We discussed the IDR story yesterday as investment flows continue to find their way back to the country given its continued strong growth and low inflation. ZAR, on the other hand, has benefitted from the combination of broad dollar weakness and gold’s recent strength, with the “barbarous relic” having rallied more than 4% in the past month. But it is not just those two currencies showing strength this morning; it is a universal dollar down day, with most freely traded currencies rising more than 0.5%.

And that’s really the day overall. There is no US data to be released today, and the Fed is just starting its two-day meeting, although there is no expectation that there will be any policy change regardless of the fact that it has been pushed back a day in deference to Election day yesterday. There is certainly no reason to believe that the dollar will reverse course in the near term, unless we see a significant uptick in US data that might cause the Fed to step up their pace of activity. However, that is not going to happen today, no matter what, and so I would look for the dollar to continue the overnight move and sell off modestly from this morning’s levels. Although I do not believe that the big picture has changed, any dollar strength is likely to be fleeting in the near future.

Good luck
Adf