Fundamental Analysis 23.10.2017 - Market Outlook

Japan PM Abe and his “Liberal Democratic Party” (LDP) won the Lower House election Sunday 22nd October 2017. The ruling coalition (LDP + Komeito) has an estimated 312 seats, two more than necessary for a two-thirds majority that will allow it to revise the Constitution to allow a more assertive military (although that also needs a majority vote among the public, which is not assured by any means).

JPY weakened on the news as Abe’s victory ensures the continuation of his loose monetary and expansive fiscal policy, a recipe for a weaker currency. It also makes it more likely that Bank of Japan Gov. Kuroda could be reappointed when his term ends in April 2018.

Historically, JPY tends to weaken for around two weeks after an election, so I would expect the trend to continue for some time. Nonetheless with monetary policy reaching its limits and the expected marginal return to further easing being rather small, the impact of the election may be less than in the past.

GBP was the big winner after Friday20th October 2017’s EU summit ended with some surprisingly conciliatory words on both sides that made it seem as if both sides were finally willing to compromise. However, I expect the optimism from Friday 20th October 2017’s upbeat Brexit comments to fade quickly and for GBP to weaken as a result. The Labour Party said over the weekend that it would back rebel Conservative Party members in demanding a Parliamentary vote on the final Brexit bill. This will no doubt make it harder to reach an agreement, since there are so many different factions that have different demands.

EUR may have started to feel the heat from Spain. Over the weekend, PM Rajoy started the legal process to dismiss the Catalan government and rule the would-be breakaway region from the center in Madrid, including taking control of the regional police. Catalan separatists meet today to work out a response. So far the crisis has been limited to Spain as the EU has sedulously eschewed getting involved, but the poor performance of the currency without any other obvious trigger makes me think that the Spanish issue may finally be starting to affect sentiment towards EUR.

On the other hand, EUR weakness could just be the counterpart to GBP strength today as people express a bullish view on GBP by selling EUR/GBP rather than buying GBP/USD. That would also make sense if Brexit is the cause for the GBP enthusiasm.

USD on the other hand gained as hopes for tax reform in the US grow.

CAD was the worst performing major currency after Friday 20th October 2017’s below-expectations CPI prints made it less likely that the Bank of Canada would take a hawkish stance at Wednesday 25th October 2017’s meeting. I agree and think that the currency is likely to fall further in the runup to the meeting as expectations shift from “tightening” to “on hold.”

Today’s market

The only significant indicator on the schedule is the Chicago Fed’s national activity index for September. Even this one barely meets my “significant” test, as it barely moves EUR/USD on a 30-minute horizon. It’s more significant after an hour, but of course a lot can happen in an hour not necessarily connected with that indicator.

Like the leading index, the Chicago Fed index is compiled from indicators that have already been released. The indicator isexpected to be higher, which could be dollar-positive.

The Chicago Fed explains the index thusly:

The CFNAI is a weighted average of 85 existing monthly indicators of national economic activity. The indicators are from four categories: production and income; employment, unemployment, and hours; personal consumption and housing; and sales, orders, and inventories. The index is constructed to have an average value of zero and a standard deviation of one. A positive index reading corresponds to growth above trend and a negative index reading corresponds to growth below trend.

This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.

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