Debate brings US election into focus

tvc_47732667c8ca4df6beb95e6e9e08b4b7The first debate between Trump and Clinton tonight should mark the start of a period in which the US election is the dominant theme in the markets. As far as FX is concerned, USD/MXN looks to be the best barometer of political sentiment. As Trump’s popularity rises, so does USD/MXN, and it has continued to make new highs in recent weeks. Of course, the trend rise in USD/MXN started some time ago, with the decline in the oil price and the general strength of the USD the prime drivers, so Trump isn’t the only cause. However, these other factors have been less notable this year, with the USD and the oil price both broadly stable, so the Trump factor is probably currently the major driver.

Having said that, we also have an informal OPEC meeting starting today in Algeria, so the oil price could once again become a factor this week. Expectations for a deal are, however, not particularly elevated, despite this morning’s statement from the Algerian oil minister saying that all options were open at the meeting and “we are not coming out of the meeting empty handed”. Few believe that Saudi and Iran can agree a production freeze (or cut) at this stage, so the risks of a sharp move may be to the upside, though the most likely move may be that the price drifts lower on disappointing news.

However, USD/MXN will be focusing primarily on the Trump/Clinton debate. A perceived Trump victory in the debate will no doubt force it higher again in the short term, but current USD/MXN levels look too high from a medium term perspective. The sharp decline in the MXN in the last two years will continue to benefit the trade balance going forward, and whatever Trump says, the consequences of a Trump victory are unlikely to be dramatically negative for the Mexican economy. Mexican growth is comparatively solid, and the current account deficit manageable. The MXN trend is still down, and should not be opposed in the absence of clear MXN positive news, but there is more potential on the MXN upside medium term.

For the majors, the significance of US politics and the oil price are less clear. Many see a Trump victory as more likely to lead to higher US rates and a higher USD, in part because it would be expected to bring an easier fiscal policy and consequently higher bond yields, but the Fed seems unlikely to react quickly so I wouldn’t place too much weight on this idea. Nevertheless, decent US numbers from now on seem likely to solidify the market expectation of a December Fed hike (currently seen as near a 60% chance) and with the T-note/bund spread at recent highs of 170bps, it’s hard to make a strong case for EUR strength, even though the Eurozone economy has remained comparatively resilient this year (and may even grow faster than the US). This morning’s strong IFO survey should also be EUR supportive. For now though, EUR/USD looks stuck near 1.12, and until we get something more clear-cut on the Fed outlook, seems likely to stay in the 1.11-1.13 range.

There is more scope for action in USD/JPY and GBP/USD. The JPY’s recent strength has been based on the combination of a lack of further BoJ action, the slightly dovish interpretation of the last Fed meeting, and some jitters about equity market levels. Personally, I think these are all very bad reasons to like the JPY. The BoJ continues to run the most aggressive QE program around, the Fed was as hawkish as it could reasonably be given recent data, and while the US equity market may start to look expensive if US rates go up, most other developed markets still look extremely good value given low bond yields. If US rates do go up and push equities lower, The JPY may gain on the crosses, but not against the USD. Having said this, I can’t currently justify opposing JPY strength given the market mood and the upcoming presidential debate. Technically, it looks like we may well be heading for 95.

GBP weakness at the end of last week was supposedly on “renewed Brexit concerns”, though it’s hard to point to a single reason why these should suddenly re-emerge, and this explanation has become a catch-all for journalists when the rationale for GBP weakness is unclear. I remain long term bearish on GBP, especially against the EUR, where fair value in the long run is nearer 0.95 than 0.85, but I don’t see the current rationale for a break above the 0.8726 August high. That doesn’t mean it can’t happen, but levels above 0.87 look a little too extended near term and should offer a short term selling opportunity in the absence of news.

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