EC September Market Commentary

Politics will also be among the September highlights. Two G7 countries, Germany and Canada, go to the polls. At the same time, in a third, Japan, the largest political party, the Liberal Democrats, will hold a leadership contest that could replace Prime Minister Suga. Merkel has led Germany since 2005. There will be a new Chancellor (September 26). Laschet, the CDU party leader, has run an uninspiring campaign, and his apparent claim to fame is that of continuity. Yet, judging from the CDU's poor showing in the polls, voters want a change. Indeed, it is becoming more likely that an SPD-led coalition (with Greens and FDP) could form the next government. A change in power in Berlin could help shape the coming debates in Brussels about making permanent some measures adopted during the emergency.

Canada's Prime Minister Trudeau is opportunistic in calling for a snap election now (September 20). He has been leading a minority government for two years. The success of the inoculation efforts, after a slow start, and an economy emerging from the earlier soft patch provides for a conducive backdrop. However, the Liberals have a difficult time in the western provinces, and it is not clear if they can regain their majority after losing it in 2019. Moreover, Trudeau's campaign initiatives seem to be tacking to the left, perhaps on ideas that it may be easier to pick up NDP or Green voters than Conservatives.

Norway heads to the polls on September 13. Erna Solberg, who has led the Conservative Party since 2004 and has been Prime Minister since 2013, will likely be denied a third term. Instead, voters look to allow the Labour Party to forge a coalition. Although Solberg was given high marks on handling the pandemic (Norway has one of the lowest mortality rates related to Covid-19 in Europe), she has fallen afoul of a backlash against economic disparities and unpopular public sector reforms. Labour is running on a platform calling for tax relief for the low and middle class, an end to the privatization of public services, and more funds for public health. In addition, it calls for an income tax hike on the top 20% of incomes. Ten days after the election, regardless of its outcome, the central bank has indicated it will most likely lift the deposit rate, which has been at zero since May 2020. It was at 1.50% at the end of 2019.

Bannockburn's World Currency Index, a GDP-weighted measure of the top 12 economies, fell to four-month lows last month, as the dollar outperformed. In fact, there were only two currencies in the basket that appreciated against the dollar: the Indian rupee, which rose by nearly 2% and the Brazilian real rose by 1.1%. Sterling, the Canadian dollar, fell a little more than 1%. August's slippage left the BWCI with a 0.7% loss for the year. 

Of note, we adjusted the weightings of the index once a year based on the World Bank's estimate of the previous year's GDP. The following charts show the new composition and the change from the previous iteration. As one would expect, changes are small. The US economy proved more resilient than most in 2020, and the dollar's share of the index edged a little higher. So do China's share and the weight of the yuan. The yen's share increased slightly as well. The euro and the UK underperformed, and the weight of their currencies was shaved. It does seem as if the pandemic is slowing India's move past the UK to be the fourth largest in our GDP-weighted index.

Dollar: On a real broad trade-weighted basis, the dollar rose for the third consecutive month in August but is about 1% lower than a year ago. The US two-year premium over Germany gradually rose from testing the year's low near 80 bp in the second half of May to almost 100 bp in the first half of August, illustrating the conviction that the Fed will be well ahead of the ECB in lifting rates. Although only a minority (7 of 18) Fed officials in June thought a hike next year would be appropriate, the market has one fully discounted. At the conclusion of the FOMC meeting on September 22, new economic projections will be made, and the market is anticipating more color about the tapering. Many observers have focused on the Fed's purchases but may have missed that starting with the next quarterly refunding, the Treasury's issuance is expected to begin declining. Moreover, indirect bidders, often foreign central banks and multilateral lenders, have been particularly strong at recent note auctions. Meanwhile, federal income support programs, including emergency unemployment compensation, coverage for gig workers, will end shortly, and the moratorium on evictions has been terminated by the courts. Most recently, increased covid infections are weighing the economy, with restaurant bookings, air travel, consumption, and confidence measures all weakening. The data surprise models have gone negative. 

Euro: The euro was turned back from the $1.19 area at the start of August and was sold to new lows for the year near $1.1665 before recovering at the end of the month to almost $1.1850. The conviction that the ECB will lag behind the Federal Reserve in the monetary cycle weighs on sentiment. Still, the ECB has to make decisions shortly or see its Pandemic Emergency Purchase Program end before the Federal Reserve's tapering is completed. It also buys bonds under a separate program, which is not nearly as flexible as the PEPP. So far in Q3, the euro has been mostly confined to a $1.17 to $1.19 trading range, and it may persist. The large speculative long position in the futures market has been unwound and in late August was the smallest since March 2020. The tragedies in Afghanistan and Syria may pose a new refugee challenge for Europe while the political climate is in flux. By the end of September, Germany will have a new Chancellor for the first time since 2005. 

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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