USD: Market reaction currently well within expectations but what next? - MUFG

Derek Halpenny, European Head of GMR at MUFG, suggests that the US election result now puts Trump on 279 Electoral College votes confirming his election victory and again the opinion polls and the expectations of financial market participants have been proved incorrect.

Key Quotes

“The first key point to make here is that the initial market response to Donald Trump winning the election is well within the range of expectations that had been anticipated in recent days, especially given the rally in the markets ahead of the vote on expectations of a Clinton victory. So what lies ahead in what is likely to be another remarkable day for global financial markets.

1) As stated above, the fallout is very contained so far. We had estimated the potential for EUR/USD to gain 4%, USD/JPY to fall 6%, the S&P 500 to drop 6% and 2 and 10-year yields to drop 25bps. Those predictions currently look aggressive. We would certainly expect bigger moves once the election is formally called. Our previous estimated moves may prove too aggressive but the current degree of fallout may well intensify.

2) The extent of risk aversion and market fallout today and over the coming days will depend to some degree on the rhetoric in Trump’s acceptance speech and a sense of what he intends to focus on in the early part of his presidency. I recall on many occasions hearing the view of many that Trump would tone down policies once in power. That’s debatable but more importantly that’s a debate for another day. We certainly shouldn’t expect signs of that in his acceptance speech and we may not know the answer to how aggressive he intends to be for some time. He has won based on reaching out to disaffected middle income and lower income workers who believe Washington doesn’t work for them. Expect a speech that will be aggressive in rhetoric on policies that won him the election.

3) The Japanese authorities have publicly stated that they are “watching currency markets closely” and that “speculative moves are behind current FX moves” and that a G-7 statement might be released depending on FX moves. However, it is plainly obvious that these FX moves are well within the acceptable range for Japan. Post-Brexit reaction saw USD/JPY drop was over 7% - the current move is less than 3% - so there is no chance of action. Furthermore, given Trump’s opposition to “currency manipulation”, the Japanese authorities would be very reluctant to intervene even if moves today become extended beyond the 100.00 level.

 4) The probability of the Fed hiking rates on 14th December has plunged and the 2-year UST bond yield has dropped 9bps. If risk-off is sustained over the coming days or weeks then a Fed rate hike on 14th December is off the table. One key question in that regard is whether the FOMC will change its tune in regard to the management of monetary policy. Yellen’s term ends in February 2018 and a change in the outlook for Fed policy is likely. But for now we should expect a steepening of the US yield curve on reduced expectations of Fed action this year. One of the notable initial price actions is the fact that the 10-year UST bond yield is just 3-4bps lower at a time when asset prices are down sharply and there is a high degree of increased uncertainty.”