Market Brief: Stress Climbs in Currency Markets

The dollar is holding steady and measures of expected currency volatility are ratcheting higher as global investors go to ground ahead of today’s US non-farm payrolls report and next week’s presidential election. Ten-year Treasury yields are edging closer to the 4.30-percent threshold after softening briefly earlier in the week, North American equity markets are setting up for a defensive move after a series of mixed earnings reports from the likes of Microsoft and Meta, and oil prices are pushing higher on reports of a potential Iranian escalation in its ongoing tit-for-tat cycle with Israel.

Forecasts for job creation in this morning’s payrolls print are widely dispersed, but are clearly skewed to the downside in comparison with September’s 254,000-position increase. According to Bloomberg’s survey of economists, estimates range from a negative -10,000 to a gain of 180,000 in October, with the unemployment rate holding at 4.1 percent. We suspect that a downside surprise could leave markets relatively unmoved - observers are generally prepared to see short-term weakness emanating from Hurricanes Helene and Milton, as well as the Boeing strike - and policymakers at the Fed are likely in the same boat. In contrast, an unexpectedly-strong number could trigger a reckoning in markets as easing expectations are pulled back.

The unemployment rate might provide the clearest view of underlying labour market fundamentals, given that its underlying survey data is adjusted to remove weather-related disruptions - and includes temporary workers. The unemployment rate climbed quickly enough to trigger the Sahm recession-dating rule in July, but fell in August and September, indicating that falling net immigration levels may be contributing to a rebalancing in worker supply and demand - as Sahm herself suggested in early August.

The British pound is selling off as gilt yields continue their climb, reflecting a hawkish repricing of the Bank of England’s likely policy path as well as a degree of sovereign risk aversion. The euro is climbing relative to sterling, and is generally exhibiting greater stability after last month’s inflation print beat forecasts, lowering odds on a more aggressive easing trajectory from the European Central Bank. Japan’s yen is trading within a consolidative range after central bank governor Kazuo Ueda made stubbornly-hawkish noises in yesterday’s post-decision press conference, keeping hopes for a December hike in play. And Canada’s loonie remains stuck in the low 1.39’s, refusing to budge ahead of a series of potential volatility catalysts. Odds on an outsized rate cut at the Bank of Canada’s December meeting are holding just above coin-toss levels as traders take a bearish view on the economy’s prospects.

One-week implied volatility in all of the major exchange rate pairs we track is well above ten-year averages ahead of next week's election, indicating a broad-based sense of apprehension with respect to the next president’s approach to economic policy. With Kamala Harris expected to largely maintain the status quo - while continuing to run large deficits - and Trump seen lowering taxes, implementing extreme protectionist barriers, cutting immigration, and widening deficits even further, the consequences for global trade and capital flows could be profound.

Prediction markets are having last-minute doubts on the outcome. Donald Trump’s lead on betting sites - including Kalshi, PredictIt, and Polymarket - has fallen sharply in the last few days, potentially reflecting blowback from the weekend’s Republican rally in Madison Square Garden, but perhaps also simply representative of a more balanced appraisal of the underlying probabilities.

The degree to which any outcome has been priced into foreign exchange rates remains unknowable, meaning that a knee-jerk reaction is still likely to hit once the race is called. As outlined in previous missives, it could take days for a result to be declared, but the reaction in historical election periods should provide abundant warning of the risks embedded in currency markets - and for currencies like the Canadian dollar and Mexican peso, the downside exposures remain blatantly clear.

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