As US Gears Up For Midterms, Dollar is Trading Heavy

Highlights
The US dollar is trading heavily though within the recent ranges against most of the major currencies ahead of the conclusion of the FOMC meeting which is widely expected to result in a new round of long-term asset purchases.  The thunder today has been stolen by the Reserve Bank of Australia.  Last month it defied market expectations by not raising rates and defied expectations again today by hiking rates 25 bp to 4.75%.  This sent the Australian dollar to new multi-year highs just above $1.00.  There is talk of a barrier that may offer resistance in the $1.0040 area.   Euro zone PMI was stronger than last week’s flash reading and this helped the euro return to the $1.40 area.   A disappointing construction PMI in the UK (51.6 vs 53.0 consensus), the weakest since February saw sterling lose ground on the crosses, reinforced the cap near $1.61.  The yen is largely sidelined and the dollar has been confined to about a 30 tick range against it. 

Japanese stocks were mixed but positive with the Nikkei up 0.06%.  The gains were led by a 1.2% increase in consumer services and 0.7% increase in health care.  China’s stocks were down as well with the Shanghai Composite down 0.2%, led by a 2% loss in telecommunications.   Overall, most Asian stocks fell on the news that the Reserve Bank of Australia surprised the markets with a hike with the Reserve Bank of India hiking as well.  In Europe stocks were mixed ahead of the Fed meeting tomorrow as investors wait to see amount of easing the Fed will provide.   Though Stoxx Europe 600 was up 0.6% led by gains in oil and gas and consumers as eurozone PMIs were better-than-expected.   At the same time the FTSE was up 0.6% followed by a 0.2% gain in the Dax.

Fiscal woes in the periphery continue, as the markets price up the risk premium attached with holding their debt.   Greek and Irish bond yields, for example, led a rise in the periphery with their 10-year bond yields up by 22bp and 8bp, respectively.  Meanwhile, Portuguese and Spanish yields were up 5bp and 4 bp.  Elsewhere, in Portugal, the PSD opposition party led claims the government has shown commitment to cut primary spending by €500mn, while Ireland’s senior government MP Mcdaid resigned, cutting the coalition majority to 3.  This further exasperated the yield premium.  German 10-year yields were down 1bp with US Treasuries, at both the 2- and 10-year tenor, flat 

Currency Markets

The US midterm election is today.  The Republican Party needs to pick up a net 39 seats in the 435-member House of Representatives to wrest control from the Democrats.  Many political insiders project them winning net 50-60 seats.  The Republicans picked up 54 seats in the 1994 midterm election, while the historic landslide was in 1938, when the Republicans picked up 72 seats.   In the Senate, the Republicans need a net 10 seats capture the upper chamber.  Insiders project they may fall shy with 6-8 seats.   On one hand, the stronger the Republicans do, the more Obama’s agenda will be curtailed and/or repealed.  Fiscally, tax cuts would be extended and spending cut.  On the other hand, this electoral cycle has featured the rise of the Tea Party and there is some risk that the stronger the Republican victory today the more difficult to may be to reconcile the two wings of the Republican Party.   The dollar does not show as strong of a cyclical pattern in the year after the midterm election.

Tomorrow’s FOMC meeting overshadows the election in the capital markets.  Two key variables are the size of the long-term asset purchases and the pace in which they are purchased.  A Bloomberg poll found that of 53 respondents, 29 expected a $500 bln program to be announced, 7 expected monthly purchases of $50-$100 bln without a specified total, 12 expected up to $500 bln and 5 did not specify the amount.  In terms of pace, 7 do not a time line to be announced, 9, expect the purchases to last three months, 17 expected three-six month duration, 9 expected six months to  one year, 5 expect through next year, and 6 did not specify a time frame.  We suspect there is headline risk regardless of what the Fed decides.  Our points have been three-fold:  1) outside the headline risk, much of QEII has been priced into the dollar with its nearly 7% decline on the Fed’s major trade-weighted index, 2) QEII should be understood as an insurance policy not life support, 3) while some monetary/financial variables may improve, the impact on the real economy is not clear and ultimately rests on financial actors respond. 

RBA raised rates 25 bps to 4.75%, contrary to widespread expectations for no change. According to Governor Stevens’ statement, the hike was triggered by a large expansionary shock to the economy stemming from high terms of trade. The other driver of the rate hike was that the economy has modest amounts of spare capacity, leading to the possible risk of rising inflation over the medium-term. Note that also supportive of today’s hike, the Bank observed that downside risk to Chinese growth have lessened, while commodity prices (most important to Australia) remain at very high levels and terms of trade are the highest since the 1950’s.  Following the unexpected rate hike AUD reached parity with the greenback again, soaring to an intraday high of 1.0013.  But the rally ran its course after stops at 1.0015 remained intact and it move back into 0.9980 on profit taking.

Eurozone final October manufacturing PMI unexpectedly revised up to 54.6 from 54.1 and versus 53.8 in September. The German reading was revised up to 56.6 from 56.1, the French reading confirmed at 55.2 and the Italian reading, which was released for the first time, rose to 53.0 from 52.6. On the whole, surprisingly positive numbers, which show that manufacturing production accelerated at the start of the fourth quarter.  The euro is a touch higher after the firmer data, following an intraday run towards 1.3994 where it settled into its post data release range.

The U.K. construction PMI declined in October to 51.6 from 53.8 in September.  This compared to the consensus survey of 53.0 so the numbers were quite disappointing. The deterioration is in line with expectations of a slowdown to U.K. growth this quarter, though yesterday’s manufacturing PMI reading came in better-than-expected, but with austerity taking effect the outlook for growth continues to wane.  Sterling was the hardest hit currency in the G10, dropping 0.3% after the release.  This large drop brought cable back in line with its 5d moving average, which if broken, may lead to short-term selling down to 1.5874, the 20d moving average.   

Upcoming Economic Releases

With the midterms in toe the economic data in the US are light this morning.  But the US reports ABC Consumer Confidence for the week of October 31 at 17:00 EST / 21:00 GMT.  And there are no central bank speeches today but all eyes will be fixed on the Fed’s actions tomorrow.