Election Odds Shift, Dollar Declines
The initial presidential debate between former President Donald Trump and current Vice President Kamala Harris in Philadelphia has concluded. Many policy questions remain unresolved as both candidates tentatively agreed to another debate before 5th November. Interestingly, Taylor Swift’s endorsement of Kamala Harris, who is perceived to have slightly outperformed Trump in the debate, may have influenced voter intentions more than the debate itself. Markets seem to concur. Betting markets now show a slight preference for Harris (56-52%) over Trump (48-44%) in winning the election, leading to a decline in the dollar and US equities during the Asian trading session. Trump is currently viewed as more favourable for these assets due to his tax reduction policies and additional tariffs.
Government bond yields have continued to decline this week. The 2-year Treasury yield dropped to 3.57%, nearing its low from September 2022. Fed futures are leaning towards a 25 basis point cut next week, with the probability of a larger cut increasing slightly from 30% to 35% since yesterday. Today’s eagerly awaited CPI report could slightly adjust these probabilities. Inflation is expected to have decreased from 2.9% to 2.6% in August, with the core rate remaining at 3.2%. With no Fed commentary due to the blackout period, investors will interpret the data independently.
Bank of Japan officials maintain their hawkish stance, suggesting a potential rate hike before the end of the year. This anticipated policy normalisation, combined with US yields falling to 17-month lows, has pushed USD/JPY to a new 2024 low of 140.50¥. The Japanese yen is currently surging in FX markets, having appreciated against 98% of global currencies since the start of the second half of 2024. Looking ahead, risks for the yen are more balanced. Asset managers have turned net-bullish on the currency for the first time this year, and with 270 basis points of Fed cuts already priced into futures for the next 24 months, there is limited room for further dovish repricing. A gradual appreciation to below the 140¥ mark remains our baseline.
Pound Declines as Growth Stagnates
The UK economy remained stagnant in July, mirroring the previous month’s performance and falling short of market expectations across all key sectors. Services output increased by 0.1%, following a 0.1% decline in June, but a 0.8% drop in production output, driven by weakness in manufacturing, resulted in no overall growth for the month. Construction output also contracted by 0.4%, after a 0.5% rise in June. Over the three months to July, UK GDP grew by 0.5%, with widespread growth in the services sector, though it still missed forecasts and is tracking the slowest quarterly pace this year.
As UK markets open, we expect rates to trend lower as traders react to the disappointing data, with some bets on rate cuts potentially added into the OIS curve. However, we do not believe this significantly changes the Bank of England’s near-term outlook. We expect the BoE to remain the most hawkish among G3 central banks, refraining from cutting policy rates in next week’s decision, where the probability of a rate cut has stayed around 20% over the past month.
Despite the weaker data, the pound was initially unaffected, buoyed by a midnight boost from US election polls showing Kamala Harris rising to 56% in prediction markets, but eventually lost the early gains. We anticipate a muted reaction from the pound ahead of the US CPI release later today. However, once that hurdle is cleared, we foresee some weakening of the pound due to the disappointing growth outlook.
Euro Gains from US Presidential Debate
The euro received an early morning boost following the US presidential debate, having previously fallen to a 3-week low of $1.103 in the prior session, as investors grew increasingly cautious ahead of key risk events this week. European equities pulled back on Tuesday, reducing the week-to-date gains by three-quarters, while bonds remained in demand. The two-year Bund yield fell to a more than seven-month low of 2.14%, underperforming US Treasuries.
On the domestic macro front, there was little to move markets, as the final German CPI for August matched preliminary readings at 1.9% year-on-year. More notably, VW ended its three-decade-old German jobs guarantee, which will effectively cease by mid-2024, in an effort to cut costs. This follows last week’s announcement of potential plant closures in Germany, the first such move in 87 years. The end of job security commitments highlights how far Europe’s largest economy has fallen behind in terms of competitiveness.
The domestic calendar remains quiet today, with the main macro focus being tomorrow’s ECB rate decision. As traders hold off ahead of the US core CPI release later today, we expect subdued spot volatility until the event. Given that the Fed has unofficially signalled a rate cut in September and overnight volatility is trading in line with recent levels, we do not anticipate significant market movements outside of the usual post-data fluctuations.
