No FX respite from election outcomes

No FX respite from election outcomes
Philip Wee, Eugene Leow21 May 2019
    Photo credit: AFP Photo

    FX: No respite from elections
    The election outcomes in Australia and Indonesia, and those expected for India, are unlikely to reverse the downtrend in their exchange rates. The 0.6% appreciation in the Australian dollar is considered a relief rally. Focus remains on rate cut expectations that pushed AUDUSD below 0.70 in the past month. The Indonesian rupiah has, after the global financial crisis, depreciated in years that reported a trade deficit. Indonesia has recently overtaken Malaysia as the worst performing stock market in Emerging Asia. The Indian rupee will weaken past 70 again because the next government formed will need to get fiscal consolidation back on track and rely on monetary policy to support growth.
    The euro is weak ahead of the EU Parliament elections on May 23-26. Polls expect the populist and far-right parties to capture about a quarter of the total vote. Capturing a third of the votes will be considered a shock because it will give these parties more sway in EU issues pertaining to the budget and trade deals and undermine unity of the single market. Hence, EURUSD has scope to break below 1.10. Similarly, GBPUSD could extend its fall to last December’s low around 1.25. Polls see the Brexit Party gaining a third of the votes at the expense of the ruling Conservative Party and opposition Labour Party. The latest sell-off in the pound has come, not from Brexit, but pressures for Prime Minister Theresa May to exit No. 10.
    Rates: Resilient US equities offers no trigger for Fed cuts          

    The US equity market appears to be sanguine about the ongoing China-US trade war. Notably, the S&P 500 is down by just 3.6% from its all time high. Comparatively, 10Y yields have been drifting low since 4Q18. While low US Treasury yields can be partly explained by dovish shift in Fed rhetoric at the start of the year, trade war fears have kept yields close to the lows of their respective trading bands. In China, sentiment is grim with the Shanghai Composite Index (SCI) down by 12.2% since the high in April. Similarly, the escalation in China-US trade tensions halted the bounce in China govvie yields, driving 10Y yields come 16bps off its recent peak. Interpreting the price action in the different markets, the impact from the trade war appears to be more negative for China, than for the US.

    There are policy and market implications if US equity markets stay resilient. We had flagged several times that the divergence in the stock market and US yields is disconcerting. With US economic data still firm, it would probably take a deterioration in financial conditions (likely triggered by a stock market selloff) for the Fed to deliver the 2-3 cuts that the market is already pricing in. With a myriad of probable trade spat outcomes (positive, stalemate, negative) to consider, we think that avoiding duration risks makes more sense with US yields at these low levels. In any case, the longer-term ramifications of the trade war is less clear and may well lead to higher US inflation in the coming years when production patterns get sub-optimised. In the short term, we would be watching to see if key technical levels (2.37% for 10Y and 2.81% for 30Y) will hold. 

    Philip Wee

    FX Strategist - G3 & Asia

    Eugene Leow

    Rates Strategist - G3 & Asia

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