Resilient dollar to ride out mid-term election volatility

Fiscal conditions in Italy continue to drive risk sentiment while the UK's Brexit negotiations seems to face increased political pressure domestically

A woman walks past election posters, one of them supporting Richard Ojeda, candidate for a US House seat in West Virginia,  in Huntington, West Virginia, October 19, 2018.
Impoverished Appalachia is a culturally conservative bastion on edge, ground zero in an opioid abuse crisis that has devastated families, and where wages are stagnant, health care costs are rising and the coal industry is gasping for air. Two weeks before midterm elections that will determine which party controls Congress, tough-talking Ojeda is urging voters in West Virginia's third district to swallow a dose of the economic populism he preaches.



 / AFP PHOTO / Michael Mathes / AFP / MICHAEL MATHES
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The US dollar continued to be well bought through October.

As I shared in my last column two weeks ago, I expected the US Dollar Index to consolidate in the channel between 94.30 and 96; and the Index has done just that in this time.

The greenback has been one of the star performers in 2018, closing six out of the past nine months higher. While I predicted this bullish performance back in 2017 and it has held true through this year, I approach next month slightly more conservatively.

On November 6 the US congressional elections take place and depending on the outcomes they could spark new themes in the US financial markets.

As US President Donald Trump continues to consolidate his power base – executive control in the White House and judicial control in the Supreme Court – solidifying Republican legislative control at next month’s congressional elections would be his staunchest test yet.

While forecasting the results of high-risk political events has proved futile over the past few years, let’s look at the possible scenarios and what impact they could have on the US markets.

The mid-term elections determine which party maintains the majority, both in the Senate and the House of Representatives. The road for the liberals in the Senate seems a long one; despite needing two seats for the majority, there are 35 seats up for re-election, out of which 26 are held by the Democrats. Of these, 10 Democrats are up for re-election in states that Mr Trump handsomely won in 2016. The Democrats would need to maintain these seats as well as gain control in states that are pro-Republican.

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The vote in the House of Representatives, where 475 seats are up for election, could result in a "blue wave" lifting the Democrat majority in the lower house – a new poll by NBC news and The Wall Street Journal show voters favour the Democrats by 9 points in Congress. On the flip side, Mr Trump enters with his highest approval ratings since taking office, and the performance of the economy will further motivate his supporters.

Gridlock in Washington would lead to a majority split in the houses with future legislation almost impossible to pass. If the Republicans sweep both houses this could open the door to further future tax cuts and deregulation. These market-friendly developments would mean US equity markets continue to build on their excellent performance in 2018 with more gains expected. The dollar will also be a big benefactor in this case.

If the Democrats were to take the majority in the House, this could lead to deeper and stronger investigations against Mr Trump, which would involve bouts of uncertainty leading to a market risk-off sentiment, and as a result sharp corrections across US asset classes in the short term.

Despite Mr Trump’s well publicised shortcomings, it would not surprise me at all if the Republicans were to consolidate their legislative base in both houses. Expect volatility to be low in the lead-up to the November 6 elections with US markets equity and bond markets to stabilise through the beginning of November in the lead-up to the vote.

While the US Dollar Index is subject to stiff selling pressure at the top of this channel, I expect the Index to consolidate at 96, with moves towards 96.40 and 97 levels, where I expect buying support to eventually fade. An improving US data docket should lead to the greenback touching 97 levels – two key pieces of data which could spark fresh rounds of dollar buying would be the pace of growth of the US economy due out on Friday (quarter-on-quarter growth in Q3 expected at 3.3 per cent) followed by the payrolls report due out on November 2 (expected at 189,000). Watch for improvements in these numbers to support the dollar and vice versa, as has been the theme through 2018.

The euro and British pound both also enter a crucial period ahead. Each currency continues to be weighed down by its own respective complications, and this trend is set to continue.

Fiscal conditions in Italy continue to drive risk sentiment, while the UK's Brexit negotiations seems to face increased political pressure domestically. Further developments will lead to punchy euro and pound trading in the weeks ahead, and I maintain a bearish bias in both currencies.

The Dubai Gold & Commodities Exchange euro to dollar contract remains weak and I keep my target from earlier in October intact at 1.13. Keep an eye out on the performance of Italian government bond yields as they will have an inverse relationship with the performance of the euro. I see the DGCX’s pound to dollar contract testing 1.2930 before exposing 1.28 levels. Upsides remained capped at 1.31 levels.

Both the ECB and the BOE convene to announce rates this Thursday and on November 1 respectively, but these should be non-factors as policy is expected to remain unchanged.

Gaurav Kashyap is a market strategist at Equiti Global Markets. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti