Dollar and US Yields Soften After Midterm Elections

  • The big story is the US midterm elections
  • The current US fiscal stance and macro outlook remain intact and the Fed will feel comfortable tightening rates further
  • While the knee-jerk reaction today is to push US yields down and sell the dollar, we think the previous drivers will re-assert themselves
  • RBNZ decision will come in the North American afternoon
  • EM FX is rallying as the dollar comes under broad-based pressure; Poland is expected to keep rates steady at 1.5%

The dollar is broadly weaker against the majors in the wake of the US midterm elections.  Nokkie and Swissie are outperforming, while the yen and Loonie are underperforming.  EM currencies are broadly firmer.  ZAR and IDR are outperforming, while TWD and KRW are underperforming.  MSCI Asia Pacific was up 0.3%, with the Nikkei falling 0.3%.  MSCI EM is up 0.7% so far today, with the Shanghai Composite falling 0.7%.  Euro Stoxx 600 is up 1.2% near midday, while US futures are pointing to a higher open.  The US 10-year yield is down 4 bp at 3.18%.  Commodity prices are mostly higher, with Brent oil up 1.3%, copper up 1.2%, and gold up 0.6%.

The big story is the US midterm elections.  The Democrats won control of the House while Republicans kept control of the Senate.  While the final tallies are still to be determined, this was the outcome that markets had priced in and is also the outcome that we think is best for markets.  Why?  The legislative branch will now fulfill one of its most important functions, which is to provide checks and balances on the executive branch.

At the same time, the current US fiscal stance and macro outlook remain intact and the Fed will feel comfortable tightening rates further.  We have expressed serious concerns about the US fiscal outlook.  As it currently stands, the budget deficit is widening even as the US economy is growing robustly.  Another shot of fiscal stimulus would be ill-advised, and the split Congress means that is now very unlikely.

While the knee-jerk reaction today is to push US yields down and sell the dollar, we think the previous drivers will re-assert themselves.  That is, wage and price pressures will continue rising, leading the Fed to tighten in December followed by at least three hikes in 2019.  Ultimately, US rates should resume their climb.  Perhaps the FOMC meeting tomorrow will serve as a reminder for the markets.

Likewise, we see no change to Trump’s approach to trade relations.  His economic team is expected to remain largely intact, and that means continued tensions with China ahead.  The status quo will prevail.  The leadup to the planned Trump-Xi meeting on the sidelines of the G20 will be a good barometer.

During the North American session, the US reports weekly mortgage applications and September consumer credit.  More election results are likely to trickle out.  Elsewhere, Canada reports October Ivey PMI.  Ahead of the FOMC meeting tomorrow, there are no Fed speakers.

RBNZ decision will come in the North American afternoon.  No change is expected.   Indeed, the market is pricing in the first rate hike for Q4 2019.  The RBNZ may take the opportunity to talk down the Kiwi, which is trading at its highest level since early August.  Break of the .6815 area would set up a test of the June high near .7060.

Germany reported firm September IP.  IP rose 0.2% m/m vs. expectations of a flat reading.  This comes after firmer than expected factory orders were reported yesterday, but the October survey data points to continued sluggishness in early Q4.  The euro is trading its highest level since October 22 and testing the key $1.15 level. Break above the figure would set up a test of the October 16 high near $1.1620.  Sterling is leading this move and is already nearing its October 12 high near $1.3260.

Japan reported September cash earnings overnight.  Headline earnings inched higher to 1.1% y/y from a revised 0.8% (was 0.9%) in August, while real earnings contracted -0.4% y/y vs. a revised -0.7% (was -0.6%) in August.  Despite a tightening labor market, wage pressures have been limited.  Sound familiar?

USD/JPY had been edging higher but has staged a big reversal today.  After trading at the highest level since October 8, the pair is now testing the 113 area.  A close below yesterday’s low near 113.10 would give us an outside down day, which signals further losses for the greenback.  So too would a break below the 12.30 area, which would set up a test of the October 16 low near 111.40.

EM FX is rallying as the dollar comes under broad-based pressure.  Looking beyond this knee-jerk reaction, we warn investors that the EM-negative drivers remain intact.  That is, US rates will continue rising, trade tensions will remain high, and China will continue to slow.

National Bank of Poland is expected to keep rates steady at 1.5%.  CPI rose only 1.7% y/y in October, near the bottom of the 1.5-3.5% target range.  The bank’s official forward guidance sees steady rates through the end of 2019, though some unofficial comments suggest a desire for steady rates through 2020.  That is too far ahead to predict, quite frankly.