Has the U.S. Election Changed the Foreign Exchange Landscape?

November 9, 2012

The last year has seen more choppiness than trend in key dollar relationships.  Such inertia has been blamed in large part on the high level of uncertainty, and the outcome of the U.S. presidential election was a central source of that uncertainty.  Note below the similarity of the dollar’s averages during the twelve months before the election, the period since mid-2012, and current spot levels.  But now that the U.S. election result is known, a chance exists for a different currency market dynamic, one with a greater element of sustained directional movement.  Or so many currency traders hope.

Period Averages Year to 11/06/12 Since end-June Nov 9, 2012
EUR/USD 1.2904 1.2638 1.2718
USD/JPY 79.07 79.01 79.33
GBP/USD 1.5790 1.5875 1.5927
USD/CHF 93.71 95.79 94.80
USD/CAD 1.0043 0.9963 1.0001
AUD/USD 1.0302 1.0365 1.0385
NZD/USD 0.8013 0.8121 0.8155

 

In many respects, the U.S. election failed to change America’s political landscape at least from the standpoint of balance of power between the Democrats and Republicans.  Market participants inferred immediately that the fiscal cliff — a wave of budgetary restraint due in January — is less likely to be modified sufficiently to avert a 2013 recession.  A second conclusion involves Fed policy, which presumably will be much more accommodative than if a Republican president had been elected, and a third result is tax policy will become less attractive for holders of U.S. securities.  In response, stocks have been sold, bond yields have dropped and the dollar is lower but not significantly so.

President Obama’s first term was marked by extremely polarized politics, and hardly any initiatives were possible during the most recent two years.  If this stalemate continues, the economy will barrel over the fiscal cliff, so there is considerably more incentive than before for politicians on both sides of the isle to strike a deal.  That may still not be enough to break the deadlock, for while there is shared agreement on a need to address the long-term budget trajectory and to strengthen near-term growth, differences over where to cut spending and how to boost revenue remain vast and fundamental.  A compromise over fiscal policy details that doesn’t abandon somebody’s core principles doesn’t appear possible.

The civility of policymaking in Obama’s second term will be set today by the President’s remarks to the nation and the immediate Republican response.  It’s been observed in market chatter that an olive branch such as rescinding a planned hike in the capital gains tax could be a profound game-changer.  In the fiscal cliff as presently programmed, such taxation would rise sharply, and that prospect has been a catalyst driving share prices lower.  Their drop is reminiscent of the knee-jerk tumble that stocks took in November 2008 after Obama’s first victory, and that earlier plunge helped drain consumer and business confidence with a dramatically adverse impact on the real U.S. and world economies.  In spite of the desire for a different script in 2012, such a public gesture by Obama is unlikely.  Even if he were prepared to modify tax promises he made in the campaign, he will want equally significant quid pro quos from the other side, so it’s best to talk publicly in vague terms and do the hard negotiations in private. Saving face will still play a huge behavioral role as the two political sides sound one another out.  The cup of U.S. political uncertainty — and by implication future tax and spending policy decisions — is still more than half full.

Other non-U.S. uncertainties shared credit for the financial market climate of the past year.  Europe has until now been the largest source of downside risk to world growth.  Politics there have been just as dysfunctional as in America.  While U.S. GDP has managed to expand at a 2% or so pace, Europe is in recession, and Japan seems to have entered a downturn in the second half of 2012 as well.  Both economies release third-quarter GDP figures next week.  The ECB and BOJ are meanwhile ratcheting up monetary stimulus, so the avoidance of an about-face in Fed policy, which was likely if Romney had won, doesn’t in fact present a marked contrast from what is happening elsewhere.  Chairman Bernanke’s new mandate doesn’t necessarily spell depreciation for the dollar

The euro sank as low as $1.2041 in July when the perceived likelihood of its break-up hit a crescendo.  The ECB’s OMT scheme defused the immediate danger, enabling the euro to move back to the high 1.20s and intra-Ezone long-term interest rate spreads to narrow.  Some three months later, conditions for the OMT are not yet met, and they might never be. Nervousness about the euro’s reversibility has returned to the fore

Yet another uncertainty overhanging currency markets for some time has been the pro-active currency policies of a number of governments.  With an abundance of economic slack in most advanced economies, inflation has stayed subdued, confounding predictions that such would rise in the wake of substantial monetary stimulus.  Price stability isn’t limited to this group of nations.  China’s 1.7% pace in October, for instance, constituted a 33-month low and compared to 4.1% in the prior year to October 2011. Low inflation enables officials to prioritize the promotion of growth, and in some countries that means proactive actions to weaken currencies.  Romney accused China of manipulating the yuan.  Monetary officials in Australia, Canada, and New Zealand have repeatedly characterized the value of their currencies as higher than they believe to be fundamentally warranted.  Swiss National Bank officials since September 2011 have enforced a ceiling on the franc against the euro.  Japanese officials routinely hint that they might resort to currency intervention, because the yen is too high.  Obama will be naming a new Treasury Secretary to replace Geithner, who wishes to return to the private sector.  Oftentimes, new treasury secretaries such as Blumenthal under Carter and Bentsen under Clinton speak loosely about the dollar, and the rhetoric tends to be self-fulfilling.

In short, the end of uncertainty does not seem at hand.  Don’t count on the inertial behavior of the dollar being over or assume that this month’s election marks a brand new ball game of wider and more sustained swings in foreign exchange.  It may be just another bump in the same unremarkable currency market landscape.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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