Markets Focus On US Presidential Election

Without a doubt the main event of next week is the US elections. On one hand, these elections are very close. The American electoral system makes it hard to predict what the outcome will be and there are too many possible scenarios to call it either way at this stage. Although Obama seems to have registered an advantage in the polls in some key states, Romney is still very much in the race and has also “won” (in the polls, of course) states that were “on the bubble” (Colorado, for example).

It’s also important to keep in mind that on Tuesday, American will vote not only for President, but also for many seats in Congress. The American system makes it possible (and indeed, such is the case rather often) that the Congress and the Presidency are held by opposing parties.

On the other hand, the US faces the “Fiscal Cliff.” As a reminder, the Fiscal Cliff is the situation resulting from the expiration (On December 31st this year) of many tax breaks for individuals and a mandatory budget cut. This sudden reduction in the budget deficit but also in disposable income poses a serious threat to the US economy. While there are a few resolutions to this situation, the path to be chosen relies heavily on the identity of the next President and the party that will have a majority in Congress.

Therefore, with such high stakes and given the unclear outcome of the elections, it is only natural that there is currently so much uncertainty in the markets. While Hurricane Sandy got most of the attention last week, and arguably helped President Obama demonstrate his competence for the job, we believe the US elections are the event that drives most of the positioning in FX markets for USD pairs.

On Friday, we got another affirmation of the fact that the US is on the right track for steady (even if somewhat slow) recovery, when the nonfarm payrolls data came in at +171K (and revisions to the September and August numbers of another +84K). This was a huge surprise and it manifested itself as such in the trading of many USD pairs and US-related currencies (see its effect on MXN, for example). Although labor is something that the Fed watches very closely, we don’t see this as something that will stop the ongoing QE3.

In Europe, there were hints of a new deal for the Greek debt; a deal that will be favorable to the private sector but also easier on Greece itself. Spain, the other seriously troubled European member state still made no request for assistance from the ECB through its OMT mechanism. While pressures are mounting, it is, in our view, only a question of time before Spain does request such aid for the simple reason that it will run out of money and raising new debt will become more costly that complying with additional austerity measures.

Next week, the ECB is expected to leave its rate unchanged at 0.75%. In addition, watch out for Industrial Production and Factory Orders from Germany (Wednesday and Tuesday, respectively). Being the number one industrial power in Europe and the last large economy still standing relatively tall in the midst of the storm engulfing Europe, economic indicators from Germany are important to gauge the direction the entire continent is going.