Market Brief: Dollar Softens Amid 'Trump Trade' Pullback

The greenback is down against all of its major rivals this morning after investors spent the weekend walking back bets on Donald Trump winning the US presidential election. Final polls released yesterday showed the race headed toward a photo finish, with NBC News deadlocked at 49 percent-and-49 percent nationally, ABC News/Ipsos giving Kamala Harris a 49 percent-to-46 percent national edge, New York Times/Siena putting the vice president ahead in five of seven swing states, and the Des Moines Register suggesting that she could win in Iowa - a state long considered a lock for Trump.

Major elements of the “Trump trade” are unwinding. Ten-year Treasury yields are down to 4.28 percent from 4.38 percent on Friday, inflation breakevens are down, equity futures are softening, and both gold and Bitcoin are down. In currencies, the Mexican peso is up almost a full percentage point, the euro, yen, and yuan are all up more than half a percentage point, and the Canadian dollar and pound are sitting on solid gains.

Data last week showed US labour markets continuing to cool even as the economy maintained strong momentum. The number of continuing claims remained elevated in the week ended October 19, and although Friday’s hurricane- and strike-distorted payrolls report failed to provide a clean read of underlying conditions, job creation in the two prior months was revised down by a combined 112,000, pointing to a weakening in demand for workers. In contrast, Wednesday’s gross domestic product report illustrated extraordinary strength in household consumption, with a 3.7-percent annualised jump in consumer spending helping to power a 2.8-percent expansion in the third quarter.

This combination suggests that the Federal Reserve is overwhelmingly likely to deliver a quarter-point rate cut on Thursday. Softening job creation rates should help support easing on an incremental basis in the coming months, but the economy’s underlying strength will make it difficult for policymakers to justify cutting more aggressively.

The Bank of England is also widely expected to cut rates by another quarter percentage point when it delivers its latest decision on Thursday, with eight out of nine members of the Monetary Policy Committee likely to favour the action. The economy has shown clear signs of slowing momentum in recent prints, wage pressures are ebbing, and inflation is nearing target in a steady manner. Markets will, however, carefully parse the Bank’s updated forecasts for any evidence that last week’s spend-and-borrow Labour budget has shifted the policy trajectory. In response to the government’s front-loaded fiscal strategy, investors have dramatically reduced the number of rate cuts expected over the next year - helping to boost gilt yields and the pound - but policymakers may disagree.

The outcome of tomorrow’s US election remains impossible to predict. Political polling has become more accurate over time, yet produced a big miss in the 2016 contest - and in the 2022 mid-terms - raising the possibility of an overcorrection in the adjustments made by statisticians. Prediction markets would seem to offer more promise, but are skewed by the presence of big-betting Frenchmen and distorted by wash trading - a practice that remains rife in cryptocurrency markets despite having been banned on regulated exchanges back in the thirties.

But foreign exchange markets are now less prepared for a conclusive Trump victory. On a trade-weighted basis, the greenback has appreciated almost 3 percent from its summer low, but that looks largely consistent with the American economy’s global outperformance and the ongoing recalibration in Fed expectations. Although positioning has turned bullish, it doesn’t look terribly stretched relative to history. And the weekend’s position adjustment has seen currencies like the Mexican peso rally back, reducing the risk discount that had grown in line with the former president’s ascendance in prediction market odds.

Post-election moves could redraw the currency landscape. Under the most extreme scenario - a full-fledged Republican sweep paired with a bellicose victory lap from Trump - we think the dollar might appreciate by somewhere between three and five percent in the days and weeks after the results are called. The euro area’s large trade surplus in manufactured goods suggests that the common currency could drop to around 1.02, while the services-insulated pound might see smaller losses. The Chinese yuan could come under sustained selling pressure - even as the central bank’s control efforts slow its descent - while the yen’s extensive trade links and inverse gearing to US interest rates could translate into a move into the high 150’s before the Ministry of Finance authorises intervention. The Mexican peso - the most obvious proxy for transshipment concerns - could plunge into the mid-1.21’s, although we think the Banxico could follow 2016’s template, stepping in if the exchange rate falls too far. Finally, the Canadian dollar - nominally exposed through massive trade links, but partially sheltered by significant energy exports** - could drop through the 1.43 threshold before correcting upward.

But currency markets love to confound predictions, and you should not mix politics with your hedging strategy. Although tactical trading opportunities will be created in the days ahead, it’s important to remember that exchange rates are ultimately driven by a myriad of factors, and could easily defy the prevailing wisdom over the next year. As always, a strategy based on diverse execution levels and time-layered hedges is likely to deliver the best long-term outcomes - while also minimising regret.

*'Wash trading’ is a form of market manipulation in which related entities simultaneously sell and buy securities from one another, artificially creating the impression that prices are rising or falling. Before the Kennedy name was associated with Camelot, assassinations, and “whale juice,” Joseph P. Kennedy was a notorious practitioner of this method for helping boost stock valuations.

**More on this in tomorrow's note.

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