FX Update: Not fully on board with the narrative driving USD lower.
Head of FX Strategy
Summary: The market seems to have conjured up a kind of Goldilocks narrative on why the US Election outcome and prospects for US political gridlock are just what the doctor ordered for inflation of risky assets globally. Indeed, USD bears are expecting smooth sailing from here on expectations that the Fed will keep the pedal to the metal and Friendly Joe will avoid any confrontational stance on trade. It just looks a bit too easy.
Today’s FX Trading focus:
Not fully comfortable with the weak USD narrative
As I outlined on Friday, the market reaction to the US Election outcome is rather jarring relative to what might have been expected, now that we (almost) know that we will be faced with two years of political gridlock in the US. Risk appetite went nearly vertical, financial conditions eased powerfully, and the US dollar headed south, taking the yen somewhat reluctantly with it.
Yes, the political gridlock on concerns that fiscal policy will prove less generous will keep the Fed’s pedal to the metal from here. And that fairly safe assumption is likely behind a good portion of the reaction function to the Election result. I suspect the other major factor was a massive unwinding of election hedges put on by those fearing a massive Blue Wave result that would have given the Democrats a mandate to raise taxes, implement green policy, and more forcefully unwind Trump’s deregulation moves. Another assumption the market is making may not be a very safe one – that Biden is set to unwind most of Trump’s tariffs and strike a more friendly stance with China and other trade partners. But I am not alone in expecting that trade relationships are far down on the to-do list initially, where the Covid-19 response is the first priority and an anti-China stance has become one of the few points of agreement that crosses party lines.
So to push back against the narrative a bit – trade is important but is not an urgent policy priority, additional Fed medicine, barring significant further innovation that could quickly get the Fed in hot water politically, is weak stuff at the zero bound. Fiscal policy is a far more powerful tool for where we are in the cycle, and the blocking majority in the Senate will likely mean that stimulus will be vastly curtailed compared to even the most minimal of Blue Wave scenarios. The charts and price action are telling us, however, to respect the price action and not to try to be the hero.
By the way, the reason for the insertion of the “almost” above when discussing what we know about the US Election results is the fact that we must wait for the Georgia Senatorial run-off races on January 5 before the full outcome is in place – if both of those run-offs go in the Democrats favour, they would have control of the Senate, with VP Harris as the tie-breaking vote in the likely event of 50-50 votes. The other bit that we need to see in place is that we will see a smooth transition, the assurance that Trump will peacefully leave the White House, with or without a concession, and that he won’t encourage, uh “shenanigans” of unknown nature among his followers from here.
We have had a week to reset markets after the US Election event risk and the quality of the move from here becomes more important to me than the initial reaction based on the above factors.
EURUSD rose just beyond the local resistance line ahead of the 1.1900 on Friday and today at times, having effectively reset the chart after the swoon into the key 1.1600 area range support ahead of (and during) the US election. The euro is actually quite soft in the crosses as the high beta trades on the US Election outcome to the US dollar are focused on commodity currencies and high-flying EM. To get the EURUSD higher here, we need to see China willing to allow its currency to head south against the greenback (the official CNY basket closed Friday at a significant level that twice formed the high since 2018 – there is only one more chart point a bit over 2% higher), a bit of a hint that the EU can figure out something bigger and more forceful on the fiscal side with the ongoing budget/recovery fund talks. A bit medium to longer term – a path out of the Covid-19 resurgence (breaking in the minutes just before pixel time: Pfizer declaring a strong result from their experimental vaccine) and especially a some real evidence that the negative real rates story for the US that the market has already aggressively priced ahead of the election, starts to get some traction. The 1.2000 level is the key upside barrier.