s the US Presidential race gears up for its final lap, Colin Cyezinski looks at the impact political rhetoric will have on the markets amid a spate of incoming economic and political announcements.
In this special report, Colin focuses on:
• Anticipation around crucial economic news, central bank meetings, and US nonfarm
• How economic data will be politically spun to suit Trump or Clinton campaign rhetoric
• The heightened market volatility that will result from this
• The likelihood of a Fed rate lift before year end
“There are three kinds of lies: Lies, Damned Lies and Statistics.”
- Former UK Prime Minister Benjamin Disraeli, popularised by US author Mark Twain and others
Considering how the US presidential election campaign has gone so far, the next two weeks have the potential to feature all three kinds plus a lot of other information and misinformation as the US election campaign comes to head amid a big week for economic news and central bank meetings headlined by US nonfarm payrolls and the US Federal Reserve Board.
All of the information, misinformation and conflicting reports that we may see through the first half of November at least have the potential to spark a lot of volatility and trading across many markets, bringing risks and opportunities. Through this time it’s critical that traders not be complacent and focus on what people do not what they say to find the signals within all the noise.
I fought the Fed and the Fed won Round One
Back in the spring economic signs were pointing toward a window opening for the Fed to raise interest rates in June but political uncertainty had increased. In May, during the Brexit referendum campaign, I suggested that if the Fed were to not raise interest rate hikes due to uncertainty about Brexit it would mean allowing events in England to influence policy in the US, throwing away 240 years of independence.
These comments attracted quite a bit of attention in the media, and it appears the rumble of George Washington, Thomas Jefferson, Alexander Hamilton and others turning over in their graves found its way across the Potomac and into DC.
Source: CMC Markets
For most of this year, ADP payroll increases (a private sector source) have been pretty consistent in the 150K-200K range per month. From January to April, nonfarm payrolls (a government source) were similar to ADP but then plunged from 144K in April down to a dismal 24K in May and miraculously recovered to a 271K increase in June. Ever wonder why?
It’s really interesting how the May plunge in jobs, which was reported in early June, arrived just in time to give the Fed a reason besides Brexit to not raise interest rates in June. It’s also amazing how the US job creation machine really kicked into gear in June in time to post a big number after the Brexit vote was over and rebuild confidence in the economy just ahead of the US July party conventions. Just a coincidence of course…
So back in the spring I fought the Fed and the Fed won. By late summer, the ruse of low employment had gone away, Brexit volatility had subsided and the Fed was starting to talk about rate hikes again. I was right about a lot of things related to Brexit, including that Leave would win, that the markets were totally unprepared for a Leave win and that a Brexit related crash in the Pound would ignite both the UK economy and a rally in the FTSE
Round Two: Politics and Upcoming Fed meeting
Generally speaking, US economic data has been pretty good in recent months but not great. Comments from a number of Fed members has indicated that one interest rate hike is still on the table for this year. Currently, traders are expecting the Fed to wait until after the election with Fed Funds pricing in a 72% chance of a December interest rate increase.
Some Fed members have suggested lately that they are indifferent between raising rates in November or December. The advantage of December is that it coincides with member projections and a press conference, and the Fed has used December meetings to make moves in recent years like the December 2013 start to tapering and the December 2015 first rate hike of this cycle. Because a rate hike is so widely expected this year, a rate hike in isolation would not make a difference to the economy or markets.
The only reason left then to suggest the potential for a November surprise is political. Conventional wisdom would suggest that the Fed would go quiet and do nothing at its November meeting in order to stay out of politics. 2016 hasn’t been a good year for conventional wisdom.
Through the campaign, Republican candidate Donald Trump has accused the Fed of keeping interest rates artificially low to boost the stock market and economy and help the Democrats. He also has threatened to sack Chair Janet Yellen at the end of her term because she is a Democrat.
I take this with a grain of salt though because Republican 2012 presidential candidate Mitt Romney threatened to fire then Fed Chair Ben Bernanke even though Dr. Bernanke had ties to the Republicans and the Bush Administration.
Still a Trump win could create confusion at the Fed and raise questions of whether Janet Yellen would quit rather than wait to potentially get sacked at the end of her term, similar to what is happening with Mark Carney at the Bank of England these days after his role in the Chorus of Brexit Doom left him on the wrong side of the Brexit vote.
The stronger potential political link between the Fed and the Democrats seems to me to be running through FOMC Governor Lael Brainard. She came to the Fed from the Obama Administration, has been identified in the press as a donor to the Clinton campaign, and has been rumoured as a possible Treasury Secretary should Hillary Clinton win the election. Dr. Brainard has been one of the most dovish members of the Fed to date but her influence could diminish should Donald Trump win.
Based on all of this, if the Fed were to deliver a November surprise and raise interest rates, it would most likely help the Democrats, because it would could be sold as a signal of a strong economy and a sign that Democrat economic policies are working. Don’t forget widespread discontent with the economy is one of the pillars of Trump support so a November rate hike could erode that discontent.
A November rate hike could be seen as a sign of a close election and that Clinton may need help to get over the top. A Trump win could create volatility in the markets and make it difficult for the Fed to act in December so a pre-emptive move in November to get a hike through ahead of this could also be a sign that a Trump victory is more possible than polls suggest.
On the other hand, if the Fed holds off in November and waits for December, it could be a sign of complacency, or an expectation at the Fed that Clinton will win the election maintaining the status quo so no need for a panic early move on rates.
Could the Fed decision signal nonfarm payrolls Friday
The October nonfarm payrolls report, due to be reported on Friday November 4th only four days ahead of the election also could send an important signal about the US economy.
Donald Trump called the 156K increase in September jobs “a Disaster” and evidence that change in the White House is needed to get the economy going again. A strong payrolls surprise, say above 250K could help the Democrats and undermine Trump’s economic platform.
If we see the Fed raise interest rates on Wednesday, a strong nonfarm payrolls report on Friday would be increasingly likely and could be used to justify a rate move. If the Fed stays the course on rates, a nonfarm payrolls number in the 150K-200K area would be more likely which would not rock the boat and would keep a December hike on the table.
Also keep an eye on the difference between Wednesday’s ADP payrolls and Friday’s nonfarm payrolls. A large gap, like with the May/June figures could suggest political influence on at least one of the reports.
What impact could the US election results have on the markets?
Stock markets in the US have been trading near all-time highs in recent months while the US Dollar has been rising in recent weeks, suggesting a lot of confidence that Hillary Clinton will win the election, the Fed will raise interest rates in December and that business/politics will essentially continue on as usual. A low VIX under 15 suggests little fear and a lot of complacency out there.
This is similar to the market conditions that prevailed in the UK just before the Brexit referendum and makes me nervous because the markets could once again be dead wrong and in for a big surprise.
Conservatives routinely poll lower than their actual support in many countries mainly because people are afraid to admit to being politically incorrect to strangers/pollsters. Rather than the usual 2-3% gap between poll levels and actual support, because of the way Donald Trump’s supporters have been demonized (called deplorables and irredeemable) and the way that so much pressure has been heaped on women and minorities to support the Democrats, this gap could be much higher, 5-6%, maybe more?
As with the Brexit vote, this race is looking to be a lot closer than it seems, and the potential for a Trump win is a lot higher than markets think.
Recent poll tracking at RealClearPolitics suggests that Trump has started regain upward momentum and is closing the gap heading into the vote. In Technicians terms, the uptrend in Trump support is accelerating again with a recent downdraft now over having bottomed out at another higher low.
With the Brexit trading experience in recent memory, it seems that some traders don’t want to be caught off side again and have started to act.
Source: CMC Markets Next Generation Trading Platform
Gold, for example, had not had any relationship with the election through much of this year but has started to in recent weeks. Gold acts as a defensive haven in times of volatility and uncertainty. When Trump stumbled in the polls after the first debate, gold fell as well, but gold has turned upward along with Trump’s poll results since just before the third debate.
While people know pretty much what to expect from the Clintons (good bad and scandalous), Donald Trump and his policies remain a wild card. A Trump win could create political uncertainty in the US and economic uncertainty in Mexico.
Source: CMC Markets Next Generation trading platform
Hostility toward Mexico has been another cornerstone of Donald Trump’s campaign (threatening to build a wall, deport Mexicans, renegotiate NAFTA, block remittances, etc.). Because of this, the Mexican Peso has been rising and falling this year along with Trump’s election prospects.
A win by Trump would be seen as a negative for Mexico, so the Peso has tended to fall as his polls have tended to rise. The USD/MXN chart above rises and falls with the USD so a rally in the forex pair would mean a decline a value in the peso.
In other words, USD/MXN goes up and down with Trump. Since mid-September, the pair had been falling as Trump’s campaign struggled, but look at recent trading, the pair has broken out of a downtrend and is turning back upward.
This indicator is based on people trading with actual money and because of this could be more reliable than polls under the “watch what people do not what they say” theme I mentioned at the top of this report.
Trading in US stocks suggests that some uncertainty about the election and the reaction to the vote may be emerging.
Source CMC Markets
The table above shows that in recent election years where the party in power held the White House, markets were up 6.89% on average for the year through the end of September, but in years when the party changed hands, the US market was down 7.40% over the same time frame.
This suggests that markets prefer stability to change and that the level of content or discontent with the economy reflected in stock prices may indicate how much demand for change is out there.
This year, stocks rose 5.38% this year through November despite a very poor start suggesting that traders expect the Democrats to keep the White House. Small declines over the last three months, however, suggests that some uncertainty has started to creep in and confidence in Clinton has started to erode. Note that in 2000, when the vote was really close and the election was contested by the Democrats, the market fell 5.0% in November.
In five of the last six election years the market has moved more than 2.0% in the November of a Presidential Election year, so regardless of what happens, we could see significant volatility trading opportunities in the coming weeks.
Friday’s FBI reversal: A preview of things to come?
Trading last Friday showed how the shifts in election momentum could have significant impacts across many markets this month. Stocks started the day off strong with traders seeing a better than expected GDP report as favourable to the Democrats.
Political and market trends shifted quickly, however, after the FBI announced it is reopening its investigation into Hillary Clinton’s emails with the arrival of new evidence from an unrelated case. This news was viewed by traders as being negative for the Democrats and opening the door to increased political uncertainty no matter who wins. On the news, stocks retreated to finish the day in the red while the Mexican Peso plunged (higher chance of a Trump win) and gold, historically a defensive haven in times of uncertainty, spiked upward.
This action showed how markets have been overly complacent about a Clinton victory and provided a taste of the Brexit level market moves we could see if overconfident investors are forced to abruptly readjust expectations toward the possibility or reality of a Trump victory.
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This commentary is based upon technical analysis. Technical analysis does not consider any of the fundamentals of an underlying company, and as such is inherently uncertain and should not be the only factor considered by an investor in making an investment decision.
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