Wednesday, November 4, 2020

Election volatility may help bears with greater downward momentum for GBP/USD

Tags
  • Dollar
  • Pound
  • Bank of England
  • Elections

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Analysts’ Pick: Election volatility may help bears with greater downward momentum for GBP/USD

  • Election volatility continues as we see a reversal in positioning thanks to a closer-than-expected fight
  • A closer look at swing states suggests that the battle in those states remains closer than seen on the surface as votes from Democrat leaning counties have yet to be fully counted
  • Uncertainty suggests that it may be wise to positioning with assets that are beneficial from either candidate
  • Fight for the Senate remains extremely close and may not see a clear majority until January in the event of a 49-50 split due to a runoff election for a seat in Georgia
  • Bank of England likely to ease, and may provide additional downside for GBP/USD

While the US elections are currently conducting the bulk of volatility across financial markets, it is still too early to say who will win in this tight race. Currently Joe Biden leads US President Donald Trump with 224-213 electoral votes but current standings in swing states look more favourable to Trump. Despite this, there are still over 25 million votes to be tallied. One thing is clear though, uncertainty spiked up across financial markets as chances of a Democrat sweep looks increasingly lower. Positioning for a clear Democrat win in both the Senate and for the presidency appears to be unwound by traders earlier today, instead flooding to low-risk assets on the day. Key states to look out for is likely to be Wisconsin, Michigan, Pennsylvania and Georgia. While the current overall standing of these states leans towards Trump, it is important to note that a large number of votes in the more populated counties within these states that are currently favouring Biden has yet to be counted. Volatility is likely to continue through the day until we get a conclusive result on the presidency. Senate control may not be clear until January if it ends in a 49-50 split due to a runoff election in Georgia that will be held on January 5th in the US.

A bulk of votes in areas with votes that lean Democrat has yet to be fully counted in Pennsylvania

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Michigan is similar as well, with votes in this state having a closer margin compared to Pennsylvania

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The closest battle is in Georgia, with the state unable to confirm the majority even with an estimate of about 94% votes being counted

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Still, volatility implicitly suggests that opportunity is present. Preparation for post-election positioning in our view will be more beneficial, due to the stronger tailwinds for certain assets in either scenario. Breaking down the policies from both Trump and Biden:

Trump:

  • Positives: Banks, Oil & Gas, Defence, Health Care
  • Negatives: Clean Energy, Tech

Biden:

  • Positives: Clean Energy, Health Care, Industrials, Materials, Education, Metals (Copper, Silver, etc), AUD/USD
  • Negatives: Oil & Gas, Tech

In addition, safe haven assets may see more upside pressure since it appears that we will not get a conclusive result until over the next few days. However, upside is likely to be limited as a result of the short-term trades that have already occurred as of this writing, indicating that safe haven will likely perform better by utilising commodities instead of sector positioning and more traditional safe havens such as yen and gold. This appears to ring especially true with Trump suggesting that he will be looking to contest the election results if Biden wins the elections by a narrow margin thanks to mail-in ballots. Also, commodities are likely to benefit from other incoming catalysts that can potentially drive markets and put political uncertainty in the backseat. This includes several vaccine trials concluding and incoming fiscal stimulus (only magnitude of spending in our view is reliant on the winner of the elections).

Coupled with the Bank of England's (BoE) monetary policy meeting this week may set up downward pressure on GBP/USD this week as the BoE looks highly probable to result in another expansion in asset purchases. At this point in time, the focus in regards to the BoE's decision is more of how much instead of when the central bank will ease monetary policy. This is especially true with the new lockdown restrictions that have been imposed by the British government as it tries to curb the spread of the second wave of Covid-19 infections.

Covid-19 cases ion the UK continues to climb, pushing the UK into new lockdown restrictions

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Economics doesn't favour a delay from the BoE either. Prior to the announced lockdown restrictions, economic data was already suggesting that the central bank's economic projections back in August was probably too optimistic. Now, given that the economy in the UK is likely to suffer even more, we expect policymakers to increase its asset purchase limit by another 100 billion pounds this week, which would allow the central bank to continue its current pace of 4.4 million pounds for about another 22 weeks to around May or June. Additionally, BoE Governor Andrew Bailey has reversed his tone on the possibility of negative interest in the UK. While we don't expect the central bank to move forward on this, especially this week, it looks likely to be a tool the central bank adopts to floor market expectations.

Latest reported data from the BoE suggests that a 100-million-pound expansion to QE will give the central bank about an additional 22 weeks’ worth of purchases

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As a result, in the short-term we expect GBP/USD to have room for more downside, potentially towards 1.2866's level. However, we expect downside to ease in the medium-term despite a weak economic outlook for the UK post-Brexit due to expected fiscal stimulus in the US regardless of who wins which should form a support for GBP/USD in light of a dollar selloff due to a dollar selloff as certainty returns over the next few weeks and as markets re-price in expectations for a fiscal spending bill.

Technical Analysis:

GBP/USD

The dollar spiked on the unexpected progress of the US presidential elections. In our view, this momentum looks likely to continue as seen in the MACD. The RSI also suggests that there is some more room for downside before we see GBP/USD bottom out. A retest of the 1.2885 support level looks likely as a result, although we don’t expect a dip much further towards 1.2773 due to uncertainty. Additionally, from a medium-term perspective, we still the outlook of sterling to be range-bound due to expectations for a weaker dollar and a weaker sterling opposing each other.

Support: 1.2885 / 1.2773 / 1.2679

Resistance: 1.300 / 1.3085 / 1.3176

GBP/USD Chart (H1)

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