Political Angst Drives Markets

The separation of politics and economics is taken for granted by many, and that makes this current period so frustrating.   Investors, perhaps like many voters, just want to get the US election over with already.    And yet this is a democratic moment, for all its warts and frailties and flaws.  What has unsettled the markets is not that there are two flawed candidates. Rather investors had grown comfortable with the idea the Clinton was going to win, and last week's announcement by the FBI has made them doubt this.

In this context, the risk is the product of the credibility of a threat multiplied by the capability.   Investors know that regardless of their personal feelings, Clinton is a known quantity.   Trump simply is not. This is not a slight.  Agents of change are by definition more hostile to longstanding practices that have become a tradition.     As recently as mid-October, Nate Silver's fivethirtyeight.com gave Trump a 1 in 9 chance of becoming President.  Over the past two weeks, and importantly, beginning before, but accelerating since the FBI's announcement, the odds of a Trump victory have tripled.

A Trump presidency has gone from highly unlikely to possible.  Generalizing while acknowledging exceptions, investors have reduced risk.  In the currency markets, this means an outperformance of Swiss francs and Japanese yen.  Gold rallied.

Bottom pickers were already emerging in sterling, and although its gains are lackluster, it has stopped falling.  The Mexican peso has been particularly hard hit, and the local market holiday on November 2 did not help matters.  But here too the peso had begun weakening a few days before the FBI revelation. The sell-off in global bonds was arrested, while equities lost ground, though Europe's Dow Jones Stoxx 600 sold off each session last week.

Many are trying to guess how the markets will respond if Trump wins next week.  While part of the price action reflects the market is discounting this possibility  On an actual victory, it seems reasonable to expect a magnitude of the same.

One market judgment that has remained constant over the changing odds has been the odds attributed to a Fed hike in December.    The December contract has closed  +/= one basis point around 0.5% for more than a month.   The Federal Reserve's statement after yesterday's FOMC meeting was little changed from September's statement.  The case for a hike "continued to strengthen," it said, and modified the "further evidence of continued progress" with the "some," seemingly signaling a low bar. 

It is not only US politics.  Consider the UK politics.  It can explain sterling's 16% slide (after the recent corrective gains) this year better than economics.  The economy remains resilient to the political vagaries.  In fact, the BOE may revise higher its growth (and inflation) forecast in the Quarterly Inflation Report that is released alongside the conclusion of the MPC meeting.   

Today's reports of the Oct services PMI and Composite PMI were better than expected and suggested that UK economy may be accelerating at the start of Q4.   The Composite rose to 54.8 from 53.9.  It is the highest since January.  The Composite averaged 51.6 in Q3 and 52.5 in Q2. 

The BOE is widely expected to keep rates steady today, with only four of the sixty survey by Bloomberg expecting a change.  It is awkward to cut rates in tandem with revising up inflation and growth forecasts.  

However, the MPC and Quarterly Inflation Report are likely to be overshadowed by the High Court ruling on the role of parliament in the Brexit decisions.  Given that parliament is on the whole less enthusiastic about Brexit, the larger and earlier role for it is understood to increase the odds of a less-hard Brexit.    Whether Brexit hard or not seems to rest on the trade-off the UK is willing to make, and these are ultimately and fundamentally political questions. 

Politics won't go away in 2017 either.  The focus will turn to Europe, with Dutch, French and German elections next year.   

The US dollar is trading heavily with sterling and the yen leading the move.  Sterling is posting gains for its fifth consecutive session.  It has approached the high since the flash crash (~$1.2375).  The five-day moving average has crossed above the 20-day average for the first time since mid-September.  The next objective is near a two-month trendline near $1.25.  Softer US yields, heavier stocks, and the general anxiety over US polls has seen the yen strengthen to one-month highs.  The dollar found a bid ahead of JPY102.50.  It started week probing the JPY105 area. 

The euro only managed to take out yesterday by a couple of hundredths of a cent before the momentum faded.  Support is seen in the $1.1060-$1.1080 area.  The dollar-bloc currencies are little changed.   The Mexican peso is softer, but the dollar is back below MXN19.50 after poking through in Asia.   It may require the stabilization of Clinton’s support for the dollar to fall below MXN19.20-MXN19.30.  

The US economic calendar features weekly jobless claims, productivity, Markit and ISM services, and factory and durable goods orders.  The September data is less important since the release of Q3 GDP.  Given tomorrow’s national figures, the weekly jobless claims will draw little attention.  The October PMI/ISM would be the most important of today’s data, but in the current context, outside of some limited headline risk, the market’s attention is elsewhere.  

Lastly, we note that succumbing to both market and official pressure, Egypt has announced it is floating its pound.  This will increase the likelihood it secures a loan (~$12 bln) from the IMF.  Egyptian officials also raised rates by 300 bp.  The pound is expected to eventually converge with the street price near EGP18.00, though the indicative pricing put the one-year forwards near EGP17.00.  

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