Once more unto the breach
Recapping last week’s US Presidential election is like surveying the aftermath of a battlefield, with sporadic pockets of fighting still ongoing though the larger battle has been won. Our new political and economic reality is still yet to be decided because the outcome was a close one. Today we’ll go through how the market is trying to reprice for the remaining unknowns of this contest and help interpret the assumptions in the rates we’re seeing scroll across the screen.
Democratic challenger, Joe Biden, has definitively beaten Donald Trump, though the lame-duck President refuses to concede the victory and continues to file cases in court to contest the results. Over the weekend, Joe Biden won Nevada and Pennsylvania, with margins of 35,000 and 45,000 votes respectively. This put Biden at 290 electoral votes, which is likely to end up at 306 when counting in Georgia concludes later today. Although several states must automatically recount when the margin is sufficiently narrow, history has shown us that any reversals in victory have occurred only when there have been less than 1,000 votes splitting the two candidates. This means irrespective of Donald Trumps courtroom antics, there is virtually no chance he can win the Presidency.
So, this outcome is good news from a market perspective at least; the results are sufficiently clear to establish a legal transition of power in January. The bad news is that Democrats have eroded their lead in the House of Representatives and are in a dead heat for the last few Senate seats. Unless they can gain a small edge in both houses of government, the Republican agenda for the next four years will be obstructionism at all costs. Heading into the election, a Biden win was synonymous with more fiscal spending which would generate inflation and a more engaged, progressive foreign policy agenda. Unless the Democrats can capture enough seats in the run-off races in early January, it seems we may only get the latter.
From the market’s perspective, there are lots of nuances being considered when it comes to pricing, but we think it can usefully be broken out in this manner. Joe Biden’s foreign policy is mostly unencumbered by the Senate seat race. Additionally, an easing of trade tensions should facilitate a redistribution of capital from developed markets to emerging markets. Part of this is dependent on demand, which is partly constricted by Covid, although some is not. For instance, the expectation is that both the EU and Chinese trade relationships will become somewhat more amicable, even though real issues remain. Furthermore, the tariff ‘club’ is expected to be a much smaller part of the diplomatic tool set.
The other issue is fiscal spending, which is an unknown until the January race determines the Senate seat allocation. The reversal of Trumpian policies is also somewhat within this column, since Biden’s ambitions may depend on the public purse strings and that has been a perennial mechanism of Republican obstructionism. In principle, both parties are in favour of some Covid employment assistance, though the camps are miles apart on actual package size. Progressive tax reform is almost certainly another policy which will require Democrat majorities in both houses, since the Republicans have spent $1bn in tax breaks since 2017.
Bottom line: The election good news is likely to be front-loaded, because the odds favour a split Senate or a narrow Republican majority. That said, heading into the classically quiet end to an election year, a change of diplomatic tone and preference may help work through a number of outstanding international issues too. Biden has already made the potential hard border with Northern Ireland a red line for US trade negotiations with the UK. The Dollar is likely to continue to drift downward as the reflation trade plays out but might encounter a reversal next year when the promise of a Democrat-led US fails to deliver.
The week ahead
Last week, FX markets were dominated by US Dollar price action as US election results gradually unfolded. With the help from small gains in the trade-weighted Sterling Index, GBP/USD climbed from lows of 1.2855 on Monday, to highs of 1.3177 on Friday afternoon. Meanwhile, GBP/EUR bounced between the 1.1030 and 1.1180 levels. Thursday’s Bank of England policy announcement included a larger than expected increase of £150 billion in its bond-buying programme. This was followed by Chancellor, Rishi Sunak’s announcement of an extended furlough scheme until March 2021. On the Brexit front, the UK-EU self-imposed deadline to reach a trade deal expires this Sunday, as clear differences remain despite ongoing negotiations. To add to the mix, Johnson is facing defeat in the House of Lords this week over his law-breaking Internal Market Bill. Bank of England Governor, Andrew Bailey will be speaking throughout the week.
- On Tuesday, the UK’s Unemployment rate to September is expected to show an increase to 4.8%, from 4.5% previously.
- Thursday’s Industrial Production for September is expected to read 0.9%, up from 0.3% in August. Meanwhile, Manufacturing Production is expected to move from 0.7% to 1.0% over the same period.
- Thursday’s preliminary GDP figure for Q3 is expected to show 15.7% growth following a -19.8% reading for Q2.
The Euro finished last week over 1% higher on a trade-weighted bases, benefiting from a weaker US Dollar as the US election unfolded. EUR/USD climbed from the 1.16 figure to the high 1.18s, breaking through the 50 and 100-daily moving averages. With US election uncertainty out the way, the deteriorating economic backdrop in the Eurozone could weigh on the common currency, as economies battle stricter lockdown measures as a result of the ongoing pandemic. ECB President, Christine Lagarde will be speaking among other major central bank leaders on Thursday.
- On Tuesday, French and Italian Industrial Production are expected to indicate contrasting activity in their sectors, with the French sector forecast 0.7% growth and the Italian sector -2.0%. Both are expected to deteriorate from August’s reading.
- Tuesday’s November German ZEW Surveys are expected read 44.3 in the Expectations Survey and -65.0 in the Current Situation Survey. Both readings are forecast deterioration from last month.
- Thursday’s Final German CPI reading for October is expected to be unchanged from previous estimates at 0.1%.
- Friday’s Eurozone GDP figure for Q3 is expected to read 12.7% growth, unchanged from previous estimates.
The US Dollar dominated price action last week, as its trade-weighted index drifted nearly 2% lower as an expected Biden victory grew stronger throughout the week. The Federal Reserve’s policy announcement quietly passed on Thursday evening, as Chair Powell kept interest rates unchanged along with bond purchases at $120 billion per month. However, the Fed boosted expectations of future increases in bond purchases, stating more fiscal and monetary stimulus is needed as rising infections cloud the economic outlook. Powell will also be speaking on Thursday afternoon.
- Tuesday’s NFIB Small Business Optimism Index is expected to read 104.4, up from 104.0 in September, almost a full recovery from the COVID induced slump in the Index.
- Thursday’s October CPI reading is expected to read 0.2% growth in the price level, unchanged from September’s 0.2% growth.
- Thursday’s Initial Jobless Claims is expected to read 730k people claiming unemployment, down from 751k last week.
- Friday’s October PPI figure is expected to show slowing growth in producer prices at 0.2% from 0.4% in September.
- Friday’s University of Michigan Consumer Sentiment figure is expected to read 81.8, unchanged from October’s reading.
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