Six Thumbnail Sketches Of This Week’s Dollar Drivers

The week ahead features four central bank meetings, the PMIs that begin the monthly cycle of high frequency data, and the US employment report. Here we sketch out the main impulses from the US, EMU, UK, Japan, Canada, and Australia.  

US: There are three drivers: politics, FOMC meeting, and the employment report.  

First, as we saw before the weekend, despite most polls and predictive markets showing Clinton with a large lead, investors realize that as unlikely as a Trump victory may be the impact could potentially be huge. In addition, even though most polls shows the UK referendum was a close call, many insist that polls underestimate the strength of insurgency movements. Barring a specific “smoking gun,” we do not expect the re-opening of Clinton’s email investigation to significantly alter voter preferences. 

The probability of a Trump victory had already begun stabilizing and recovering a little. A few swing states seemed fluid and may have swung toward Trump, but not enough to change the likely electoral college outcome. The odds also favor the Democrats taking the Senate by a slim majority. The Democrats had little chance to garner a majority in the House of Representatives, and this does not appear to have changed either.  

The reaction to the news in thin pre-weekend activity gave investors a sense of what to expected our assessment is wrong. Speculators will likely sell the Mexican peso, and the Canadian dollar will underperform. The euro and yen may be among the biggest beneficiaries. Stocks will sell-off and bonds will rally.  

Second, there is practically no chance that the Federal Reserve changes policy at this week’s FOMC meeting. A move this close to the election would be unprecedented. The Fed’s forecasts (dot plot) will not be updated, and there is no press conference scheduled. While these obstacles are not impossible to overcome, they are formidable. Moreover, the hawks on the Fed recognize this and do not appear to be pushing for a hike now, but that does not mean that there won’t be any dissents. To the contrary, we expect 2-3 dissents.  

The FOMC statement is unlikely to change substantively. There will be some minor tweaks to recognize the recent data and the improved growth. Last October, the FOMC statement pre-committed itself to a hike in December. We don’t think the Fed has to go to this extreme now.  The market is pricing in a 70%-75% of hikes before the end of the year. A year ago the odds were around half as much. The Fed can indicate that the bar to a hike is low, needing only continued improvement in the data and no major negative shocks.