FX: Currencies on edge ahead of US elections
As the US enters the final week of a long and bitter election, and with the High Court throwing the UK’s Brexit plans into doubt, political uncertainty has been the chief driver of the currency markets.
An ABC/Washington Post national poll put Donald Trump fractionally ahead of Hillary Clinton in the US presidential race this week, causing the USD to fall against G10 currencies. Other US asset prices also suffered.
Meanwhile, sterling got a lift this week from news that the government will not be able to trigger Article 50 without a vote in parliament. That threw into question the timing of the UK’s departure from the EU – or even whether it will at all.
That news saw sterling appreciate by around 100 basis points against the USD, after a month of falls which began when prime minister Theresa May stoked fears of a ‘hard Brexit’ at the Tory party conference. The pound went on to have its worst month since the referendum was held in October, falling by 5.3% against the dollar and 3.1% against the euro.
With the UK and US at a major political crossroads, markets are preparing for the possibility of a fundamental repricing.
Paresh Davdra, CEO and co-founder of RationalFX, says: “In the event that Trump did win the election, it would be a very interesting time of revaluation for global markets – especially the relationship between the post-Brexit pound and a post-Trump dollar.”
These have not been the only currencies that are being driven by political pressures. In South Africa, ZAR is outperforming after South African president Jacob Zuma dropped his bid to block the release of a potentially damaging report investigating government corruption.
“While Zuma has survived numerous scandals already, local political analysts believe that this time is different,” says Brown Brothers Harriman (BBH).
And in Korea, president Park Geun-hye replaced her premier and finance minister as she tried to contain the damage from another influence-peddling scandal, which is contributing to downward pressure on the won.
However, it is the US election that has global markets on tenterhooks.
“The prospect of a Trump presidency and the dramatic changes that it could entail is rattling investors and spurring position squaring,” says BBH in a note.
Craig Erlam, senior market analyst at Oanda, says: “Trump is an unknown quantity. Clinton is seen as offering more of the same, which means a continuation of the current low growth the US has been experiencing.
“With Trump, things could get better. He could renegotiate Nafta [North American Free Trade Agreement] and TPP [Trans-Pacific Partnership] and get better deals for the US. But he could also tear them up, and it’s not clear what that would mean for US jobs or global trade.”
Jane Foley, head of FX strategy at Rabobank, adds: “There is concern that Trump’s promises of tax cuts could significantly enhance the US budget deficit and that his protectionist policies could bring a rise in cost-push inflation, which would reduce real incomes and overall demand.
“On top of that, since he has never held an elected office, the broader political uncertainty connected with a Trump presidency is significant.”
The USD has fared better against emerging-market currencies, which are always in the firing line when markets shun risk. Indeed, the currency suffering most from the political uncertainty in the US is the Mexican peso, largely because Mexico is seen as the single biggest beneficiary of Nafta.
With the Real Clear Politics average of polls showing Clinton’s lead has been eroded to 2.2 points, Kit Juckes, a macro strategist at Société Générale, tracked that spread against various FX pairs and found a particularly strong correlation with USD/MXN.
Juckes says: “It’s easy to see Trump as bad for Mexico in particular, and for US trade-dependent economies in general, but there are limits to what a president can legislate. This isn’t like the UK’s EU referendum, where the potential medium-term economic damage of leaving the single market is much clearer.”
Among G10 currencies, Juckes observed the strongest correlation in CAD/JPY. USD/CAD looks more stable, but given the USD itself has been falling, that stability implies CAD is weakening over its own Nafta concerns, especially since it will have been given a boost by oil’s recent modest rebound above $50.
The chief beneficiaries of this risk-off sentiment have been the yen and Swiss franc. Rabobank’s Foley says while on paper the Swiss franc is an excellent choice for safe-haven flows, investors might be deterred by the Swiss National Bank’s (SNB) strong efforts to dissuade speculation.
“Not only does the SNB maintain negative interest rates but it had made it very clear that FX intervention is a policy tool,” she says.
“[Meanwhile,] by almost all academic measures the CHF is overvalued and currency strength comes at a price,” not only a disadvantage for exporters but disinflationary pressure. For 2016, the SNB forecasts inflation at -0.4%, while next year it is only predicted to rise to 0.2%.
That could make yen the biggest beneficiary. Despite persistent strengthening against the USD, it is not, by most measures, overvalued, while Japan faces greater pressure not to intervene directly in currency markets.
Jane Foley, Rabobank
“The fact that intervention is a bigger risk in the CHF is likely a contributing factor behind the trend lower in CHF/JPY between mid-2015 and mid-2016,” says Foley.
“In recent months the currency pair has remained range bound, but we would judge a rise in US political uncertainty as favouring the JPY vs the CHF and would look for a move back towards the June low near CHF/JPY102 in such circumstances.”
Gold has also benefited from global political uncertainty.
Oanda’s Erlam says gold’s “new role as an apparent Trump hedge has seen it rally back towards $1,300, where it has currently run into some resistance. This was an important support level for gold from June to September, so it’s going to take a significant push to drive it back above here.”
Volatility is likely to persist until the outcome of the election is known, and possibly well beyond. If Trump does win, volatility could persist for months, and most agree that would mean a delay for the rate hike most now expect the Fed will deliver in December.
However, Société Générale’s Juckes believes markets will calm down relatively quickly after the election, regardless of who wins.
While the last days of the US election have seen the dollar weakening and Treasury yields rallying, Juckes says: “On a three- to six-month view, I’d rather be long dollars and short treasuries than the opposite, whoever wins the election.”