How USD Reacts to Democrat or Republican Win

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Daily FX Market Roundup 10-22-12

How the Dollar Reacts to a Democrat or Republican Election Win
EUR: Drops for the First Time in 6 Trading Days
GBP: Quiet Trading in Sterling
CAD: Will the BoC Drop Plan to Raise Rates?
AUD: Early Release of Midyear Economic Outlook
NZD: Gold Unchanged, Oil Down 1.5%
USD/JPY on a Tear

How the Dollar Reacts to a Democrat or Republican Election Win

While the sell-off in stocks show that equity traders remained nervous about the earnings season and the outlook for the financial markets, currency traders are not convinced that tougher times lie ahead. High beta currencies such as the euro, British pound and New Zealand dollars did not slide alongside stocks and USD/JPY powered higher. At the same time, FX traders are not blindly optimistic because the Canadian and Australian dollars weakened against the greenback. Investors are still nervous with only 2.5 more weeks to go before the U.S. elections and Chinese leadership change. Of course, Europe’s debt crisis is also a continuing headache for the market. With no major U.S. economic data released today and nothing material expected over the next 24 hours, the most exciting event will be the third and final U.S. Presidential Debate. While the debate will be focused exclusively on foreign policy, the dramatic contrast in tones of the first and second debate will make this one a session not to be missed.

Unfortunately, it is difficult to tell how the debate will impact the dollar if at all. When Republican Candidate Mitt Romney won the first debate on October 3rd, the dollar weakened against all major currencies and stocks soared. When President Obama won the second debate, U.S. equities also enjoyed a nice rally, the EUR/USD appreciated but the dollar rose against the CAD and NZD. Republican policies tend to be friendlier to business but based on a study conducted by Fidelity, U.S. stocks do better under Democrats than Republicans. Analysis of the past 12 elections over the last 48 years found that stocks enjoyed an average annualized return of 12% under Democrats and 6% under Republicans. The performance of the dollar is even more confusing and less consistent. We took a look at how the Dollar Index performed between the time a Democrat or Republican won the election to the day they took office on January 20th. We’ll look further out as the week progresses. Our Bloomberg Dollar Index data only goes back to 1975 and while this data is interesting, statistically it is not significant because it only covers 9 elections and 6 different Presidents. As you can see in the table below, there is very little consistency in how the dollar performs because it appreciated after the victories of Republicans Ronald Reagan and George H Bush as well as the victories of Democrats Bill Clinton and Barack Obama.

EUR: Drops for the First Time in 6 Trading Days

While the euro traded higher against the U.S. dollar today, it struggled to hold onto its gains throughout the North American session, ending the day well off its highs. The initial enthusiasm was created by the better than expected results from the weekend’s Spanish regional elections. At best, most of us expected Prime Minister Rajoy’s Popular Party to hold onto their 38 seats but they performed even better, securing 3 additional seats for the party in Rajoy’s hometown of Galicia. This should give the Prime Minister confidence to ask for a bailout if he chooses to do so – which is the primary question at hand. With 10-year Spanish yields at 5.45%, Spain can afford to wait but the longer they delay, the more uncertainty there will be in the Eurozone. Investors still want Spain to ask for a bailout and remove a major uncertainty from the market and even other countries in region are nudging Spain in that direction. French President Hollande said this morning they will be supportive if Spain asks for a bailout. For now, “the market has clearly breathed a sigh of relief that Spain remains relatively unified and that Mr. Rajoy can proceed with plans for stabilizing the country’s economy but concerns persist and any strong outpouring of secessionist desire in November 25 elections could once again revive the threat of fracture in the region,” according to our colleague Boris Schlossberg. “Mr. Rajoy faces yet one final test on November 25th when the economically powerful Catalonia holds its regional elections. Catalonia has been a political cauldron with calls for separatism running high. The Catalan government has not only called for a snap election but also for a non-binding referendum on the issue of secession. Secession is considered to be illegal the Spanish national government and it has warned that it will not allow such a vote to take place. Therefore the Catalan elections are being viewed as litmus test of the general population on their genuine political desire for sovereignty. The strength of the win by the ruling GUI party which has taken on a secessionist mantle is being viewed as key barometer of Spanish national unity.”

GBP: Quiet Trading in Sterling

The British pound ended the day unchanged against the U.S. dollar and slightly lower against the euro. No U.K. economic reports were released this morning and the only piece of data due over the next 24 hours is the British Bankers Association’s loans for house purchases. For the most part, low interest rates have supported gradual improvements in the housing market and the BBA data should confirm that. This is a quiet week in terms of U.K. data but Thursday’s GDP report is important because it will determine whether the U.K. economy rises from recession. For the time being, we expect the weakness in the British pound to be limited across the major currencies because there is a good chance that given recent improvements in economic data, the Bank of England will hold monetary policy steady for the rest of the year.

CAD: Will the BoC Drop Plan to Raise Rates?

The big focus on Tuesday will be the Bank of Canada’s monetary policy announcement. Of all the central banks meeting this week, the BoC rate decision is the one that could cause the most volatility in its currency because it is the only one where the central bank could actually shift its monetary policy stance. Canadian policymakers are not expected to change interest rates but throughout the summer, the BoC has been telling us that they want to raise rates. However recently their tone has been shifting with Bank of Canada Governor Carney telling us that growth forecasts will be revised lower. The central bank is also committed to keeping inflation around 2% and with CPI undershooting that level, there is a good chance the BoC will drop their hawkish bias and shift to neutral which would be very bearish for the Canadian dollar and drive USD/CAD higher. In addition to the rate decision, retail sales are also scheduled for release tomorrow and economists are looking for consumer spending to slow. The New Zealand dollar held steady but the Australian dollar extended its losses after the Treasury released its midyear economic and fiscal outlook report earlier than usual. With the budget running significantly behind forecasts, the government needed to make new changes now to get fiscal finances back on track. Their decision to release the report early could also nudge the RBA to cut interest rates again before the end of the year.

USD/JPY on a Tear

USD/JPY is on a tear and the currency pair has not experienced a down day in the last 8 trading days. The combination of stronger U.S. data and weaker Japanese data along with expectations for more easing from the Bank of Japan compounded the gains in the currency pair. This is more a story of Yen weakness than dollar strength because the Japanese Yen traded lower against all of the major currencies on the back of exceptionally weak trade numbers. Last month, the trade deficit more than doubled because of weaker Chinese demand and a strong Yen. The 10.3% decline in exports and 4.1% rise in imports confirm that the performance of the Yen had a lot to do with the deterioration in trade activity particularly since the currency hit a 7 month high against the U.S. dollar in September. In this morning’s special report on Fresh Opportunities in USD/JPY, we talked about the government’s desire to see more easing from the Bank of Japan. Prime Minister Noda has a vested interest in stimulating economy ahead of a tough election battle and with the opposition refusing to debate a bill that allows the government to issue debt to finance its deficit, the government will need to rely on stimulus from the central bank. Even without political pressure, the rapid deterioration in the Japanese economy will make it necessary for the Bank of Japan to ease again. Aside from the weakness in trade, consumer demand remains soft according to the latest supermarket and convenience store sales. We suspect that small business confidence will drop as well, adding more pressure on the BoJ.

Kathy Lien
Managing Director

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