News & Analysis

The US election is set to eclipse all other events in terms of significance for financial markets next week, despite the calendar featuring otherwise important events such as Fed and Bank of England meetings, as well as non-farm payrolls. 

Analysis on the election and possible outcomes is available in our comprehensive US election primer, so today’s week ahead will instead focus on next week’s calendar, as well as providing some brief commentary on market positioning and recent news flow, as well as highlight the importance of initial exit poll results on election day.

Monday 2nd November

Over the weekend, markets received data from China in the form of its official manufacturing, non-manufacturing and composite PMIs for October. The PMIs are expected to show little change from August while continuing the theme of the recovery now being driven by the services sector. On Monday morning at 01:45 GMT, the Caixin manufacturing PMI – an export, private-sector orientated gauge of activity centred on China’s east coast – is released. The Caixin PMI measure tends to undergo a more accurate seasonal adjustment process, meaning the impact of the golden week is likely to have less of an effect on this measure, but expectations still expect a minor slowdown in the manufacturing sector after months of continued growth.

Eurozone Manufacturing PMIs for October are to be completed by Monday, with the Spanish and Italian readings at 08:15 and 08:45 GMT respectively, and the final prints for France, Germany and the eurozone published by 09:00. While services could be severely damaged by the new measures put in place to prevent further Covid contagion, industrial production seems to lead the economic recovery in the area thus far. Preliminary German data has hinted at the best performance of the sector since April 2018 with a flash reading of 58, with a better-than-expected overall economic rebound in Q3 largely due to the robust manufacturing activity. Other major eurozone economies have shown a promising recovery of manufacturing activity too, although heavier reliance on services in France, Italy and Spain may drag on the wider recoveries there.

The impact of the data on the euro might not be substantial as markets are already pricing in the chances of a double recession in the eurozone as well as the prospects of further monetary expansion by the ECB.

With US elections dominating the weekly calendar next week, it would be easy to neglect this data that otherwise would be of major relevance for european investors amid the second wave of the pandemic.

The day of PMI releases continues with the UK manufacturing PMI released at 09:30 GMT. This release is a final reading, however, and expectations suggest no change from the initial 53.3 reading is likely. The manufacturing sector is unlikely to show the effects of recent lockdown measures, as new orders continued to rise in October. However, Wednesday’s final reading of the services PMI may begin to show signs of these negative effects. Wrapping up the deluge of manufacturing PMIs is Canada’s at 14:30 GMT. September saw the manufacturing PMI rise from 55.1 to 56, registering its third consecutive month of expansion, while new orders rose to 57.7 from 55 in August. The rapid pace of expansion in Canada’s manufacturing sector is unlikely to prove sustainable, leading to a decline in the overall reading. However, this is to be expected. The market impact of such an event will be muted, with the main focus resting on the service sector and how consumers react to the imposition of tighter lockdown measures in Quebec and Ontario.

Tuesday 3rd November

Turkish CPI kickstarts Tuesday’s data calendar at 07:00 GMT. Given the latest depreciation in the lira past the 8.3 level to date, authorities’ focus on inflation is beginning to build. The CBRT raised its inflation forecast for the end of 2020 from 8.9% to 12.1% on Wednesday of this week, stating that “curbing risks to the inflation outlook is critical to the maintenance of a healthy and stable growth.” The CBRT’s words and actions haven’t aligned, however. Interest rate hikes are the best way to mitigate against lira depreciation and curb inflationary pressures, but at the last meeting the CBRT opted to avoid hiking its politically sensitive benchmark rate and instead continue raising rates via backdoor mechanisms. This hasn’t been looked upon favourably by markets and if the CBRT is serious about curbing the inflationary outlook, an emergency rate hike may be forthcoming. For the rest of the day, the data calendar is quite light. Instead, the market will be focusing on the election in the US – more on this below!

Wednesday 4th November

Following on from Monday’s manufacturing PMI release, the Caixin services PMI and composite readings from China are due out at 01:45 GMT. The focus on the service sector reading will be intense given the resumption of domestic consumption in China. With China’s economy set to grow 2% this year while other major trading partners tighten lockdown measures in response to second waves, the extent to which domestic consumption can drive Chinese growth will be key.

Expectations suggest the service sector PMI will rise from 54.8 to 55.0 in October.

Services have been seriously affected by recent efforts to contain the rapid spread of the virus in Europe, with bars and restaurants closed in Germany, a wide lockdown brought back in France and several restrictions put in place in Spain and italy. The ugly confirmation of the heavy toll on the sector is yet to be full illuminated by Services PMIs for October on Wednesday, along with the overall impact expected on business activity in the eurozone at 09:00 GMT. Spanish services are set to show the worst picture relatively, as uncertainty about new potential measures weighs on investor sentiment ahead of the winter season. Tense dialogues between local and central governments have been a common theme in European countries, dragging on business’s plans even further. Even with another recession in Q4 already expected by markets, the main concerns are centered around the labour market, heavily concentrated in services.

 

PMIs for Europe’s service sectors start to shudder with further lockdown measures imposed

The final reading of the UK services PMI will be released at 09:30 GMT on Wednesday, rounding off the day of data. Considering the data was compiled between the 12 and 21st of October, the final services PMI is unlikely to have deviated from its flash reading of 52.3, which in itself doesn’t highlight the true extent to which the latest lockdown measures have hampered the service sector.

Thursday 5th November

The data calendar begins in the Nordics on Thursday with Sweden’s flash GDP estimate for Q3 at 08:30 GMT. The data point is expected to print at 5.0% QoQ, which would suggest the economy has already recouped half of its Q2 losses. Going forward, the outlook is less certain with a resurgence in cases both domestically and abroad, but the Q3 data will provide an area of positivity for the nation. The data calendar then turns to Norway where the Norges bank is set to release its latest policy decision at 09:00 GMT. Little deviation in September’s forecasts, which envisaged no rate hikes until 2022, is expected despite the faster than expected recovery in the labour market and strong credit growth data. Governor Olsen can look towards the resurgence in cases to temper calls for an earlier beginning to the normalisation cycle.

The Bank of England is then up at 12:00 GMT, with analysts’ consensus view signalling an increase to its Assets Purchase Program by 100 billion pounds to £845 billion. The move was expected prior to the recent increase in virus infections over the last few weeks, which makes it almost a certainty at the current juncture. Britain has recently reported the highest death toll of the pandemic since May, with experts forecasting an even more deadly second wave ahead. Markets are already mulling prospects of a soon-to-come lockdown in the UK after political circles have increased pressure on Boris Johnson for more proactive measures to face the pandemic.

Likely downgrades to the economic outlook are set to accompany the policy decision, with both the 2020 and 2021 growth forecasts potentially downgraded…

The 5.4% shortfall estimated for Q4 on a yearly basis in August´s projections is likely to be revised down under 8% in light of Covid-related restrictions to economic activity. While Brexit talks still provide hopes of a barebones deal by year end, prospects of negative rates should remain muted on next week´s policy meeting. The impact of the latest Fed policy decision, due at 19:00 GMT is set to be diluted on a week dominated by a particularly uncertain presidential election in the US. While there is a strong case for the Fed to step aside from policy actions this time around, any unexpected market reaction in the event of a contested election result won´t pass unnoticed by the central bank. The scenario of a severe constitutional crisis on Trump´s reluctance to concede defeat might trigger high market volatility around the globe. The outcome of the elections and the ensuing changes in fiscal policies will be another factor to account for by the Fed looking ahead. A likely blue sweep in Congress and the White House brings higher prospects of fiscal expansion in the year ahead, pumping up growth and labour market recovery. With major divergence on policy implications resulting from different scenarios, comments from the Fed after the election day will be heavily scrutinised.

Friday 6th November

North American labour markets will be the focus for markets in a data sense on Friday, with both the US Nonfarm Payroll data for October and Canadian Labour Force Survey due out at 13:30 GMT. While all the US agenda will likely be outshined by the general elections next week, the print of nonfarm payrolls on Friday 6th at 13:30 GMT is set to divert investor´s eyes. Median forecasts signal a net addition of 600k jobs in October, in line with the fading recovery of the US labour market since the sharp contraction earlier this year. Data is set to depict the yet more damaging impact of the virus on employment, with a surging virus cases in the US over the following weeks. The weaker performance of the US labour market is poised to highlight the negative impact of the delayed lack of fiscal support, after weeks of bipartisan talks on the next round of stimulus failed to deliver the much needed help before the elections.

In Canada, the labour market still remains some 720,000 jobs away from its February level.

While the labour market recovery has been sizable and robust to date, job gains are expected to slow hereon in.

In the Autumn Business Outlook Survey, hiring intentions rose only modestly to 26, substantially below 2019’s average of 36. The outlook survey saw that despite 34% of firms experiencing capacity pressures, with 10% experiencing significant capacity pressures, firms were willing to look through it without changing their production levels. With headwinds to the recovery of social consumption in Canada plentiful under the resurgence of Covid-19 and the consequent lockdown measures imposed in Ontario and Quebec, the net change in employment is expected to be substantially below August’s value of 378,200 – it may even be negative. With the data not due for another week, economists’ expectations are yet to be published.

 

Employment recovery continues to lag in hardest-hit sectors of Canada’s economy

 

US ELECTIONS

MARKET POSITIONING AND LAST MINUTE THOUGHTS

Tuesday’s presidential election is uniquely significant for the global macro outlook for a number of reasons. The differences in the outlook for trade and economic policy under different outcomes for the Senate and White House are arguably the largest in modern history, while the risk of a disputed election result looms large. These uncertainties mean that the potential for volatility through Wednesday morning and beyond is unusually high – a point easily demonstrated by a quick comparison between FX option implied volatility this year and the equivalent point in the 2016 election.

 

EURUSD option implied volatility 26/10/2020

EURUSD option implied volatility on 26/10/2016

To summarise the views from our US election primer:

  • Biden’s tax and spending plans are likely to be pro-growth and pro-inflationary relative to the current baseline. Ultimately, this will mean a faster bounce for the economy and inflation than a scenario where less stimulus is implemented. Any tax increases will be back-loaded, and indeed the latest analysis suggests that over a 2-year horizon the bottom half of the income distribution will actually see substantial tax cuts. These households are likely to have a higher propensity to consume, and so even Biden’s overall plans for tax changes are likely to be simulative in the short run. The Federal Reserve has stated clearly it will take a far more relaxed approach to falling unemployment numbers so there is little risk of a sudden hawkish shift in monetary policy, clearing the way for a weaker US dollar in the medium term.
  • However, Biden will need a Democrat majority in the Senate to pass even the core of his stimulus, infrastructure, and tax plans. This seems likely looking at political prediction markets, but is far from assured. A GOP Senate would greatly curtail fiscal policy and possible delay stimulus.
  • A Trump White House, GOP Senate, and Democrat house would be something of a status quo outcome, with some short-term stimulus likely but longer-term tax cuts less so. Full Republican control of the White House and legislature seems the least likely scenario, and would likely see substantial stimulus as well as tax cuts.
  • Given the high amount of concern about a disputed election and possible legal challenge, a clear result for either candidate followed by announcements of stimulus may create a short-term relief rally for the dollar.
  • The policy differences between the two prospective administrations have a particularly interesting relevance for the Canadian economy and dollar. Significant fiscal stimulus from either a “blue wave” or “red sweep” scenario would improve external demand for the Canadian economy. Biden’s proposed reductions in subsidies for fossil fuels may improve the competitiveness of Canada’s own energy sector, as may increase in corporation tax. Increased pipeline access for Canadian oil, for example via the controversial Keystone XL project opposed by the Obama-Biden White House, would become significantly less likely.

Calling the market reaction on the night to any given outcome is difficult to do with any reliability, as the 2016 election proved.

After an initial knee-jerk dollar sell-off as it became clear that Trump had won, markets quickly recovered following a victory speech filled with promises of tax cuts and infrastructure spending. However, it seems safe to say that the greatest risk to the dollar and potential source of volatility is a disputed election. Donald Trump himself has fueled this anxiety, repeatedly refusing to commit to accepting the results of ballots while attacking the validity of mail-in voting. The large proportion of mail-in ballots in many states poses the risk that results are delayed, and offer an opportunity for legal challenges seeking to invalidate or disregard votes. Donald Trump directly referenced this possibility this week.

Hopefully the few states remaining that want to take a lot of time after November 3rd to count ballots, that won’t be allowed by the various courts, because as you know we are in courts on that. We just had a big victory yesterday in Wisconsin on that matter.

-Donald Trump, press conference 28/10/2020

A contested election is a spectrum that begins with a simple refusal to concede, and progresses to legal challenges seeking to invalidate mail-in votes. Beyond this, disputes may proceed to the legislature or the Supreme Court, scenarios for which there are few precedents. Similarly, the market reaction to these types of events may range widely. Previous US political risk events saw mixed reactions in markets, but on balance the risks would seem to be skewed to the downside for the dollar, and to the upside for CHF and JPY. Crucially, initial exit poll results on the night of the election will be important for judging the scope for Donald Trump to attempt to dispute mail-in voting. This is due to the “blue shift” phenomenon, where Democrat voters disproportionately use mail-in voting methods, meaning that as these ballots are counted a potentially close race can swing away from a Republican candidate. A strong initial majority in a state for the Democrats will greatly reduce the scope for this type of dispute, and so election night polls will be even more closely watched than usual.

 

G10 and select EM performance vs USD during US political risk events

 

Average FX returns 40 days following US elections

 

Authors: 
Ranko Berich, Head of Market Analysis
Simon Harvey, FX Market Analyst
Olivia Alvarez Mendez, FX Market Analyst

 

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