Morning Commentary: US Elections: The Vice Presidential Debate

Foreign Exchange - Morning Commentary
US Elections: The Vice Presidential Debate
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
This past week delivered two major events surrounding the U.S. election. The first was the expected presidential debate, but the second was the unexpected announcement of President Trump’s positive COVID-19 test.

Both events have resulted in a rise in market odds for former Vice President Biden becoming president and a democratic sweep of Congress. Trump’s positive COVID-19 test also prompted the markets to introduce a new tail-risk scenario with Vice President Pence’s odds of winning the presidential election rising above near zero. This increase represents the fact that Pence is the legal successor to Trump and would be the likely replacement should the Republican presidential nominee position become vacant.

Nevertheless, despite increased odds, the chances of a Pence presidency remain very low. The real takeaway from last week’s events is that they underscore the heightened uncertainty around the U.S. election process. Trump reiterating his skepticism over the integrity of mail-in votes during the presidential debate is especially poignant ahead of an election that will feature a record and possibly decisive number of mail-in ballots.   Trump’s positive COVID-19 test also adds uncertainty for obvious reasons.

The confluence of these events gave an example of how markets would react in response to a sharp rise in election uncertainty. In past commentaries, we suggested that a contested election would lead to two reactions. The first would be U.S. dollar buying as market risk off triggers de-risking and reserve currency buying. The second would be a negative U.S. dollar effect representing idiosyncratic risk stemming from fears of a U.S.-centric institutional failure. In hindsight, the market’s initial reaction was in line with what was expected. Equities sold off with high beta currencies weaker but reserve currencies, such as the Japanese yen and Swiss franc, stronger. The exception to this is the Chinese yuan, which also strengthened. This likely reflects the yuan’s unique sensitivity to the election outcome due to the candidate’s differing trade policies. Overall, this reaction made sense as it reflected both the initial concern over Trump’s incapacitation and the potential medium-term implication of how recent developments could influence the election outcome.

Specifically on the election outcome, market focus will be on tonight’s vice presidential debate, which has taken on more than normal importance. This increased importance not only comes from what should be a more substantive policy discussion than seen in the first presidential debate but also from each candidate seeking to prove his or her ability to be president. The vice president has always been said to be a heartbeat away from the presidency, but this applies now more than ever.
  • After accusing House Speaker Pelosi of negotiating in bad faith and calling off stimulus talks yesterday, President Trump has somewhat walked back those comments. These measures include $1,200 individual checks, $25 billion for airlines and $135 billion for the Paycheck Protection Program. While this latest development has eased some of the market’s concerns over stimulus talks, the reality remains that no aid before the election is the most likely outcome.  Senate Republicans viewed no aid as preferable to a big package and House Democrats viewed no aid as preferable to a skinny deal.  But by initially calling off stimulus talks, President Trump curiously set himself up to take blame for the government’s inability to pass needed aid. 
  • Big Tech remains under pressure, with the U.S. House introducing a series of proposals designed to curb the power to Big Tech. This is nothing new but could warrant keeping an eye on under a Biden presidency and especially with a Democratic sweep.
  • The U.K. announced that it plans on quitting Brexit trade talks if a deal isn’t seen by Oct. 15. The pound initially sold off sharply on this headline but has since recovered much of its losses. Over a longer window, the pound sits significantly higher than its post-referendum lows, meaning there is scope for much more of a risk premium to be priced in.
  • Economic data out of Germany and Spain disappointed the markets. German industrial production contracted 0.2% month over month versus expectations for a 1.5% increase. Spain’s industrial production number also contracted 5.7% year over year versus expectations for a contraction of 4.9%. In related news, European Central Bank President (ECB) Christine Lagarde warned against the premature withdrawal of ECB support measures.
  • China’s foreign reserves data came in at $3.143 trillion, which is down from the recent peak of $3.165 trillion seen in August. Likely, this change is due mainly to valuation effects, as the U.S. dollar has gained significantly against most major currencies since last month, depressing the USD value of non-dollar reserve holdings.
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