The US presidential election is less than 45 days out. Given all the elements at play in the global economy and geopolitics, it is easy to see why this election is seen as one of the most important, if not the most important, election in decades. According to a Pew Research Center poll, a record 83% of respondents say this election matters, up from 73% in 2016 and 63% in 2012. As would be expected, consequential elections tend to draw bigger turnouts as illustrated by the 2018 mid-term elections. If those mid-term turnout numbers provide any clues, this year’s turnout could challenge the record 63% turnout set by the 1908 presidential election.
While investors acknowledge the importance of this election cycle, it is less clear what the markets have priced in. On one side, you have November implied volatility up aggressively which implies the expectation for elevated uncertainty. At the same time, general market risk premium is relatively subdued. A possible explanation for this could be the markets taking polls at face value. Namely, this means a Biden victory accompanied by a refrain from implementing policies that could derail the economy.
The market’s assumption on a Biden victory stems from Biden’s 7.5 point average lead in national polls. For comparison, Clinton led Trump by only 2 points at a similar point in 2016. However, it has to be noted that things are getting tighter. Since August, Trump has been cutting into Biden’s lead in swing states. According to the Real Clear Politics poll average, Biden’s lead in top battleground states has fallen to 3.5 points from 6.3 points in July. Again for comparison, Clinton’s equivalent lead was 2.4 points in 2016.
In reality, the polls may be understating how close the race is as a material number of survey participants have indicated they would not report their true preference on telephone polls due to concerns their responses were not truly anonymous. Finally with the debates still to come, many undecided voters should firm up their preference soon.
Given the above discussion, a close race seems like a reasonable assumption. History has shown close races to be less supportive of US assets and this could be especially true this time around with Congress struggling to agree on a second pandemic stimulus package. It would seem that the closer we get Election Day, the less incentive there is for the two sides to cut a deal.
Interestingly, the biggest risk from the market’s perspective might not be who wins but for a prolonged contested outcome. Both sides have already begun preparing for a legal battle and rhetoric about the fairness of the election has already begun. Should the race be close, the chances of contested outcomes that lead to prolonged uncertainty and create a policy vacuum with negative consequences substantially increases. In light of these risks, safe haven assets including the US dollar could find support, despite its recent sell off, as market volatility rises.
The overall view remains for further consolidation. The USD remains under pressure but is unlikely to start sustained trend depreciation. On the euro side, good news from the recovery fund has largely been priced. A less-dovish-than-expected ECB should provide some support and chatter remains around the ECB and EUR strength. This is countered by rising infections in Europe and a pullback in European economic surprises. These push/pull factors likely net out to more range trading.
The Bank of England kept its policy rate and its bond purchase target unchanged by a 9-0 vote. Notably, the bank surprised markets by announcing it is studying how negative rates might be implemented. The combination of the Internal Market Bill and negative rate news dropped the GBP but optimistic comments out of the EU on a deal limited the downside move. Looking forward, the GBP should remain pressured as it faces a sizable fiscal cliff and rising hard Brexit risks. On the Internal Market Bill, PM Johnson granted a strategic concession to Troy rebels in a sign that he realized he overplayed his hand. How this bill ultimately plays out and the EU response are key near term catalysts.
The Bank of Japan held rates unchanged as expected but upgraded its economic assessment. On the political front, Suga has been confirmed as the new leader of the LDP, which confirms the continuation of Abenomic policies. This should relieve some of the risk for rapid JPY appreciation but the bias for gradual appreciation remains. Uncertainty around the virus and upcoming US presidential elections support safe haven assets, and real rate differentials continue to skew support towards JPY appreciation.
Over the past couple of weeks, the CAD has outperformed most of its G10 peers as it played catch up on previous underperformance. Given this, on a YTD basis, USDCAD remains at the bottom of the G10 table, reflecting Canada’s unique vulnerability to COVID-19 shocks. Canada depends on foreign financing and with yields expected to be near zero for the foreseeable future, the currency would have to adjust weaker should there be insufficient foreign investment to cover trade and FDI deficits. The expectation remains for the loonie to be supported with the risk for consolidation as the CAD is now near fair value.
Headlines around US-China tension continue to come out but ultimately the markets are viewing the recent actions/rhetoric from both sides as largely symbolic. A strong balance of payment position and the market consensus for USD weakness form the base for a stronger CNY. Capital inflows, especially on the bond side, have been strong and are expected to be persistent as the global search of yield continues. Longer term, geopolitics remain a concern especially as we get closer to the US election, but for now, expect the yuan to be supported.
The overall view remains unchanged for the Aussie. Further strength as optimism around reopening remains but this strength should be capped given recent equity price action. Risks from China remain as reports indicate that China is looking for other iron ore suppliers. This past week brought a good jobs report, but it’s notable that most of the jobs created were part-time ones. USD weakness should support AUDUSD but domestic headwinds and the AUD’s correlation to equities, that have turned shaky, should limit gains.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to remain unchanged at 4.50%
Expectations for rates to remain unchanged at -0.75%
Expectations for rates to remain unchanged at 0.00%
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
US Existing Home Sales
Expectations for a 6.0 million print
US Manufacturing and Services PMI
Expectations for a 53.3 and 54.5 print, respectively
US Initial Jobless Claims
Expectations for a 840K print
US Durable Goods
Expectations for a 1.3% increase
EZ Manufacturing and Services PMI
Expectations for a 51.9 and 50.5 print, respectively
UK Manufacturing and Services PMI
Expectations for a 54.0 and 55.9 print, respectively
German Manufacturing and Services PMI
Expectations for a 52.5 and 52.9 print, respectively
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