Hive Intelligence Report: Is USD An Effective Hedge For Contested Elections?

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This week we had a lively debate on why oil bears are returning, whether the USD is an effective hedge for contested elections, and, of course, if last week’s FOMC meeting signalled a hawkish Fed or if Chair Powell is just a lousy communicator. And we had many other intriguing market nuggets, including tactical and strategic cross-asset views. As a reminder, these are the latest thoughts from our network rather than the official Macro Hive views.

US Elections

Who Will Pick the Next Supreme Court Justice, and What Does it Mean for the Election Outcome?

•In the event there is not a Supreme Court nominee before the election, what happens if there is a contested election and the Supreme Court is split 4-4? Does Nancy Pelosi, Speaker of the House, become interim president and be allowed to put up a new nominee? Who, then, will decide the election outcome? So, in theory, we could be in limbo for months well into 2021. A split court in the wake of a contested election seems disastrous and not entirely out of the question.

•Donald Trump stays president until 20 January. Settled by 8 December when the electoral college meets. If the contested election reaches the Supreme Court before 8 December and the court is split 4-4 then the result stands, and the person challenging the result loses.

USD as an Effective Hedge Against a Contested Election

• From BoA: ‘If the race does tighten from here, history tells us to expect increased perceived policy uncertainty and increased risk premium in the next 50 days.’
• ‘The short USD trade is the most crowded trade in the market right now. In our view, investors are underestimating the vulnerability of their short USD positions to increased market volatility. A contested election will likely result in fiscal policy paralysis, and the Fed’s option of cutting short-term rates into negative territory is constrained by solvency concerns.’
• On the one hand, November implied vol. across markets has been bid up aggressively (Charts 1 and 2), suggesting the perception of a high level of uncertainty (despite the calm, vol. implies an autumn storm). On the other hand, general market risk premium is surprisingly subdued. AUD/JPY, 5-year inflation breakeven five years forward, and MSCI World — our favourite measures of macro risk premium — are all trading near or at their pre-COVID high, suggesting a benign central scenario.

• Lesson #1: ∆policy uncertainty (close races) > ∆policy uncertainty (landslides)

• Lesson #2: ∆risk premium (close races) > ∆risk premium (landslides). ‘For the four tightest presidential races over the past 50 years (2000, 2004, 1976, and 2016), the US yield curve steepened on average 11bps while US equities fell 1.4% in the final two months of the

election (Sep. and Oct.). In contrast, for the four widest races (1984, 1980, 1988, and 1996), US

yield curve flattened while US equities rallied on average.’

• ‘In general, we like owning perceived ‘safe haven’ assets in the next few weeks. More

specifically, we like owning JPY and bull flatteners. We would also stay away from EM for

now. Our EM strategy observed recently that EM tends to weaken during US election campaigns’

• MH Network view: A very close election will keep pressure on US financial asset risk premia. That means dollar flow out, right? So, the rationale is that people sell risk and park proceeds in cash, i.e. USD. You are implicitly thinking of foreign investors selling profits and repatriating them.
• The world is massively long USD, like liabilities as well. Japanese and European banks are. Commodity finance is dollar-based. Think how many corporates have consistent dollar financing needs. In most crises, liquidity becomes an issue, and people flee to the most liquid market there is, i.e. dollar T-Bills and UST. Isn’t this why the Fed invents swap lines? So I still believe the dollar will strengthen during risk aversion. I would argue it is even more potent than last time, given that the tactical community is close to limit short as well.
• World trade is in dollars. But unless a country is a net importer (negative trade balance), it doesn’t mean that it needs to have dollar liabilities. And even then, it might not need to borrow dollars if it has a positive net international investment position (NIIP). The dollar short has been greatly exaggerated. The BIS data, for example, tends to look only at the liability side of the balance sheet. Take Japan, which is the biggest beneficiary of the Fed dollar swaps – yet Japanese investors are massively long USD assets.

Thoughts Post FOMC

• Risk vulnerable here. The Fed disappointed, and if fiscal also disappoints then we’re in the election window without a backstop.
• The Fed was weirdly hawkish, only because Chair Powell knows he is out of ammo at this point and cannot go it alone. And in the next six weeks, a lot can change. This AIT is feeling very BoJ.

What Do You Mean?

• Look at their SEP forecasts: they do not project inflation running above 2%, but they want to convince us they can and will aim for it. It’s just like the BoJ would say they could do all these magical things, but then their forecasts were either too low or never hit. Basically, they are still trying to be internally consistent with other macro factors like slack in the economy, and they realize they cannot push up inflation just by changing the goalposts.

Fed’s Poor Communication

• It was sad to watch Powell go through this. He is good at crisis-fighting, but when it gets all policy wonky and econ-heavy, he cannot blind them with science.

• We’re agreed on the Fed/Powell thoughts above. They have not thought out the implementation of AIT well. And, yes, BoJ started AIT in 2016 with zero effect: a central bank cannot generate inflation, it can only not stand in its way once it starts going. But I am surprised stocks are down so much. The talk is lots of strikes around 3400 on SPX for tomorrow. Having said that, we are still within the range – 11,000 has been the wing of that range for NDX.

• The Fed is being hawkish and unclear on AIT. It is clear they want fiscal and regulations to take over, and they would rather not provide more stimulus.

• I disagree. Between Jackson Hole and now, the Fed has delivered earlier and stronger than what many Fed analysts expected for Nov. or Dec. Where we are today is a direct consequence of the fact that Powel is thoroughly unqualified to be the chairman of the Fed and the one who delivers such nuanced policy. He is the worst Fed chair I can recall by miles. He is worse than the ECB’s Wim Duisenberg, even. My view is that people should be selling USD, buying gold, and buying stocks here because this is an overreaction to a dovish message delivered by a bad communicator.
• The Fed is now playing second fiddle to risk sentiment because it is clear they will not move, at least on rates, for the foreseeable future. I made the mistake of staying focused too much on the Fed balance sheet in May-June (Fed tapering) and missed the rally back then, which as it turned out was driven much more by fiscal stimulus (and other factors). And if anyone has any doubts about the Fed balance sheet – even if they stop buying, which they will not, bank reserves will grow almost by default. But all this will not mean anything if there is no additional fiscal stimulus.
• FAQ on Fed’s new regime change by J.P. Morgan:

Latest Oil Market Dynamics

Bears Taking Over

• The key agencies for the oil market (EIA, IEA and OPEC) published their monthly outlooks on the oil market last week. Demand was revised down, supply revised up – net negative for prices.

Source: Energy Aspects,IEA,EIA and OPEC

The hedge fund community swung from being neutral or even mildly bullish towards oil in late August to strongly bearish by the end of the first week this month (positioning report).

• The resurgence of coronavirus, signs that OPEC+ countries are becoming weary of output cuts, and the lack of significant disruption to US oil production from Hurricane Laura were all likely triggers, individually and in combination.
• UAE is making the Saudis unhappy. Th chart below says they produced 180’000 bd more than their ‘allowance’. UAE’s August output showed 10% compliance, July 41% compliance vs agreed production cuts.

• Reuters: Saudi Energy Minister Warns Oil Market Gamblers Will Be Hurt ‘Like Hell.’
• $5 downside to oil from here – market got short. CTA short-covering — Mexico hedge came in too. COVID is hitting Europe hard. But it will be tough if the USD continues declining.

What Happens to Iranian Oil Supply if Joe Biden Wins?

• Scotiabank: ‘Nearly 1,850 kbbld of crude oil supply will eventually come back into the market from previously sanctioned Iranian supply if Joe Biden wins the US presidential election, in our view.’
• ‘This supply will not flood the market on Wednesday, 4 November, the day after the elections; rather it will take a considerable amount of time for governments to negotiate and agree upon a JCPOA version 2.0, allow the IAEA to follow-up with inspections, and proverbially dot the i’s and cross the t’s. If Trump wins the election, then we expect another four years of sanctions on Iran, which would be comparatively more bullish for energy market.’

Other Interesting Comments, Links, Podcast and Charts

Cross Asset Views by JP

Gold

• Too reflated. Remain ultra-bearish on risk in the medium term. As a haven, it’s useless; it acts more like a risk asset. Hence, I closed short gold, added to long JPY vs USD, CHF as the vaccine reality seeps in; it’s time to short gold.

GBP

• Deal or no deal, the UK will thrive. Deregulation is the name of the game; a no-deal scenario deregulates more.
• That is a long-run view. With the BoE moving towards negative rates and a Brexit deal still uncertain, the cable will move lower in the short run.

CNY

• I attended a group call with PBoC. Their message was that their trade war management framework for RMB basket was intact. That implies 98.0 as being a ceiling (96.5 now), so there may still be upside. I think they are going to use this type of window guidance and SOE USD purchases to provide a balance in the FX market. Meanwhile, all foreign banks are falling over themselves to upgrade RMB forecasts.

What are Prime Minister Suga’s Policies and Will He Allow a Firmer JPY?

• I expect Suga will focus most on the third arrow of Abenomics, i.e. economic reform, which will only have a long-term impact on markets. There will not be a GST for a couple of years. The BoJ will continue with the same policy as before (but realistically, they have run out of bullets).
• Be aware also that this Suga government may not last long, and LDP infighting may come back. So policy stability is not guaranteed. In summary, it is natural for the yen to strengthen gently.

Crypto

• Bitcoin as an Investment
• Easy Diamond Trading Set to Be Available for First Time

First G10 to Hike Rate

• ‘Norges Bank will be the first central bank [in the G10 currency sphere] to raise rates,’ said Bjorn Roger Wilhelmsen, partner and chief economist at Nordkinn, an absolute return macro hedge fund based in Stockholm.

Interesting Podcast

• Paul Marshall – 10 ½ Lessons from 23 Years at Marshall Wace. This covers lessons relating to market efficiency, skill, portfolio construction, shorting, man and machines, size, and careers.
• Podcast interview of shrewd investor Michael Green, who argues that value investing is a short vol. strategy and that passive investing is killing liquidity. He also discusses why he thinks vol. will go higher.

Fascinating Charts

• Nice chart by Morgan Stanley Research: the share of furlough vs share of moratorium. If you are in the top right, life will be hard when all support schemes end.

The Fed just reported the second-lowest 4-week rolling QE of the year. Could this be crushing stocks?