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November FX outlook – the US election and beyond

The USD showed a firm tone through October as the market steadily priced in a higher probability of a Fed rate hike by the end of the year and the market assessment of the chances of a Trump presidential victory also gradually declined (though this was seen as positive for the MXN). GBP remained weak through the month, suffering a massive “flash crash” in early Asian trading on October 7 in just a few minutes. The US election will be the primary focus in November, and the USD bias remains higher if the expected Clinton victory materializes as the market starts to look towards a Fed rate hike in December.

1) The US election – November 8th •The US election is the main event for November, and by now it is clear that the markets see a victory for Clinton as generally USD positive and a victory for Trump as negative for riskier currencies, notably the MXN. The market is priced heavily in favor of a Clinton victory though the latest FBI investigation has pushed the polls slightly less in her favor.
•In the last week before the election it is unlikely that too much will change, and the anticipation of the vote will likely prevent major market moves ahead of time. This suggests that the ultimate reaction may well be greater than expected, as the effect of events before the election may be effectively stored up for the post-election reaction.

2) US monetary policy. Key events: FOMC meeting November 1/2, Employment Report November 4 •No change in policy should be expected from the FOMC meeting – it is perceived as too close to the election and with no press conference scheduled it is simpler to wait for December. However, the market will be looking for any signals about Fed action in December. The best indication would be from any upgrade to the assessment of the economy that may be seen after the slightly stronger than expected Q3 GDP data on October 28. It is also possible that there could be further dissenters to a decision to leave rates unchanged, but this seems unlikely. The proximity of the election should also mean there is no immediate sustained market impact to the employment report, but anything that affects the chances of a December Fed move is likely to have an impact after the election.

3) UK still in focus. Key event: Quarterly Inflation Report and BOE decision November 3 •The Bank of England Quarterly Inflation Report on November 3rd, accompanied by the MPC decision, will be the first focus. Very few expect any change in policy this month, despite the post-Brexit indications from Carney that a further rate cut is likely before long, because the UK data has been significantly stronger, and GBP significantly weaker, than the Bank of England expected.
•There are also continuing questions surrounding Brexit. The UK is not expected to formally announce its intention to leave until late Q1 2017, but there will be some market interest in any court decision on whether the referendum decision to leave the EU needs to be ratified in parliament. It is not clear when this decision will come, but if the courts do decide that parliament needs to vote, GBP can be expected to rally because there is some chance parliament will vote against it.

4) OPEC and the oil price. Key event: OPEC meeting November 30th •The oil price has broadly held the higher levels achieved following the late September announcement of OPEC’s intention to reduce output. But prices have started to fall from their highs on news that Saudi production in October had actually risen from September levels and unproductive talks with non-OPEC members. There will be more talks before the full OPEC meeting on November 30th, but the chances of success look low, though there is always the chance of further (empty) verbal commitments. The price risks consequently seem to be to the downside, although recent data indicating declining crude stocks has provided some support.

Currency outlooks

EUR/USD
EUR/USD has broken into the bottom half of the year’s range in the last month, but has so far failed to break below the key support in the 1.08-1.0825 area. Nevertheless, rising yield spreads in favor of the USD suggest downside risks for EUR/USD if we see the expected Clinton victory in the election and the November Fed meeting and October employment report support the idea of a Fed move in December. This is the central expectation and data will need to be weak or the Fed unenthusiastic to deflect the market from this belief. Even so, progress towards the 1.0527 low from November 2015 and the 1.0463 low in March 2015 is likely to be difficult. While the USD is favored because of the expectation of higher US rates, the European data has been reasonably solid and the Eurozone risks that helped cause the 2015 moves to the lows are less severe than they were. But EUR/USD has never regained the levels seen before the Brexit vote and Brexit concerns continue to weigh on EUR/USD a little as well as on GBP/USD. An attempt to break below 1.05 may not be seen until December when there is also an ECB meeting to clarify their policy stance. The performance of GBP and perceptions of Brexit will still likely be a factor for the EUR.

GBP/USD
The “flash crash” in Asian hours on October 7th was one of the sharpest moves in GBP/USD ever seen over a short period, and even most of the decline was quickly reversed, it has left its mark on the currency which has never regained the pre-flash crash levels above 1.26. While there was no obvious proximate cause of the move, the underlying concerns about “hard” Brexit remain the main issue for GBP, and are unlikely to go away any time soon. The only real chance of such concerns being reduced near term is if the court challenge to force the government to have parliament vote on the issue is successful. It is unlikely that parliament will prevent the government from pushing on with Brexit, but some influence on the terms that Britain seeks is possible.
A rate cut is seen as unlikely in November, but the lack of one can’t be expected to trigger a significant GBP recovery and in the absence of news on Brexit a retest of the flash crash low at 1.18 looks quite likely.

USD/CAD
USD/CAD dipped to test 1.30 in mid-October helped by the strong Canadian employment report for September and the rise in the WTI oil price above $50. However, the dip proved short-lived and as the oil price has slipped and the market has priced in higher US rates, USD/CAD has edged up to the highest level since March, above 1.34. Further gains seem likely if expectations for a December Fed move continue to gain ground. While a Trump victory could be expected to be bad for the CAD, introducing political risk premium, a Clinton victory would probably not be good, as the market will start to focus on a December Fed move, and the USD/CAD uptrend remains intact. The oil price remains a wild card, but the risks look to be to the downside with the support from the promise of an OPEC production cut fading in the face of evidence that output is little changed. Bias is upside towards 1.38.

USD/MXN
As the market barometer of election sentiment, USD/MXN edged lower through October as Trump’s star faded, and should be expected to benefit further on a Clinton victory (and vice versa). While the MXN is ultimately vulnerable to a weaker oil price, it is probably weak enough to already to hold its level even if oil slips a bit from here. More of a concern may be how the equity market and other risk assets react after the election. Although the knee jerk MXN reaction to a Clinton victory would certainly be more positive than to a Trump win, the MXN could subsequently suffer if the equity market started to worry about the impact of a Fed rate hike. Technically, the 200 day moving average could prove key support for USD/MXN trend. It has held above this since late 2014 except for a brief dip below at the end of April. Currently it comes in just above 18.40. A break of this could be expected to trigger some squaring of short MXN positions.

USD/JPY
The JPY weakened through October in line with the general trend of USD strength, though there were some periods of short term JPY strength on the crosses as sentiment about the BoJ fluctuated and equities had periods of weakness. However, the 105.50 area is a key technical resistance for USD/JPY. USD/JPY has not been above its 200 day moving average since December 2015, and this currently comes in at 105.63 and will be tough to break convincingly ahead of the election. However, if a break does come it could signal substantial gains for USD/JPY as yield spreads look likely to continue to widen in favor of the USD, with the BoJ effectively fixing Japanese long term yields near zero. However, as with USD/MXN, equity market reaction could prove crucial. Weaker equity markets could prevent a break and provide support for the JPY.

Compliments of Bannockburn Global Fox – a member of the EACCNY