Morning Commentary: Y2K All Over Again

Foreign Exchange - Morning Commentary
Y2K All Over Again
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Market volatility, especially in the US equity markets, has markets on edge.  The equity market recovered some of its losses yesterday and have opened higher today but continue to seek out a trend amid extreme and sustained uncertainty.  

As we look forward, it is reasonable to say that uncertainty will be the dominant risk for the foreseeable future; geopolitical risks are rising; the trend towards innovation and adoption of new technological solutions has accelerated; and economic slack will remain through at least 2021.  

So while the USD should continue to face near term challenges, the background outlined above makes a sustained USD downtrend unlikely.  Many have argued that the equity selloff was a tech-focused one driven by technical factors and not broader economic ones.  While there may be some truth to the technical story, it is undeniable that US election uncertainty has risen as FX option pricing shows a steadily increased risk premium for most currency pairs.  With the possibility of the election outcome not known by the night of November 3 due to increased absentee and mail in voting slowing the count and potential legal challenges from both sides, election uncertainty could ultimately be higher than previously thought.  

As a case study, we can look at the 2000 US election that was not decided for more than a month after election night.  Asset price action between election night and when the Supreme Court ruled on December 12 could provide clues as to what to expect this year.  During this period in 2000, the US enjoyed strong economic performance with the euro, Swiss franc and gold outperforming and equities (S&P 500) underperforming.  Note that the yen didn’t behave like a safe haven as the country continued to struggle with its post-bubble financial crisis.  Clearly, caveats apply as there are differences in markets conditions between then and now, but the current macro backdrop does support a similar uncertainty-increasing environment of a contested election in 2020 as seen in 2000.  

For the balance of this week, central bank decisions will be the main focus with the Fed, Bank of England and Bank of Japan all announcing rate decisions over the next couple of days.  Expect the Fed to take its first steps in shifting its policies towards accommodation rather than improving market function.  Similarly, the BoJ will remain on hold with any action limited to existing COVID-19 measures.  Finally, the Bank of England should also be on hold with the risk for a dovish shift and downward GBP pressure on negative Brexit headlines.
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • The Problem Solvers Caucus plan, which has been worked by a group of 50 Republicans and Democrats, is attempting to break the stimulus deadlock with a $1.52 trillion relief bill.  Steven Mnuchin has hinted that the White House would be open to accepting such a plan. 
  • The Aussie dollar is the G10’s best performer overnight as the RBA’s minutes showed it didn’t plan on easing again anytime soon.  Better than expected Chinese data also boosted sentiment.  
  • The Chinese yuan continues to strengthen and sits around its strongest levels since mid-2019.  Overnight, China’s industrial production and retail sales number both beat expectations, supporting the view of a continued economic recovery.  The US-China yield differentials also sit near all-time highs which continues to draw strong foreign flows into the Chinese bond market.  With central banks around the world all in lower for longer mode, the search for yield should make these Chinese bond inflows resilient.   
  • The UK government won the first vote on the controversial Internal Market Bill last night as expected.  The bill is expected to face more significant resistance as it continues through the Commons and the Lords, but Johnson’s majority in the Commons and convention for the Lords not to block Commons legislation gives this bill a good chance of becoming law.  The view remains that this bill is for negotiating leverage as much as anything else as the UK government needs to show it is willing to accept a no deal exit.
  • UK unemployment rose to 4.1% from 3.9% and came in at market consensus.  However, the low participation rate and the expiring government furlough program adds noise to this number.
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