Envelope drop boxes and ballot printers for in-person voting for the 2024 US presidential race. AFP.
It remains a tug of war for the USD. On the one hand, the Federal Reserve (Fed) is still waiting patiently for the all-clear from the data to ease. This keeps the USD supported. On the other hand, more balanced global growth should keep the USD strength in check. The global growth picture is broadening in favour of better European growth. The Fed is also far from alone in delaying or at least slowing the pace of rate cuts. Under our baseline forecasts of two rate cuts in the US and UK this year compared with three cuts in the Euro area, policy divergence may remain limited.
Even where potential policy divergence is clearer like between the US and China, the CNY has remained relatively stable with the help of a defensive FX policy. The JPY rebound on suspected currency interventions in April has also helped to calm fears of an abrupt depreciation of the CNY. Other emerging market central banks have also shown limited tolerance for significant divergence and large currency moves. Latin America central banks like Mexico and Brazil became more prudent about rate cuts while Bank Indonesia hiked rates in April to defend the IDR despite inflation at target.
Cross asset volatility is back to pre-pandemic lows
Source: Bloomberg, Bank of Singapore.
The limits to divergence and the Fed taking rate hike off the table have helped keep not just FX but also volatility for other asset classes subdued. While risk assets have wobbled a little in the last two weeks, the VIX Index is still close to multi-year lows and the MOVE Index -- a gauge of interest rate volatility in the US Treasury market – has fallen to its lowest level since February 2022. Carry could continue to perform. But we are also increasingly mindful of the risks.
One of the key risks to our baseline of benign financial market outlook is a US election outcome that impairs US engagement with the rest of the world.
Focus on US election risk could pick up by the first presidential debate in late June
Source: Bloomberg, PredictIt, Bank of Singapore.
Low implied volatility means it is cheap to buy protection against such event risks. Such strategy looks sensible as a hedge against US election outcomes that could result in shifts in fiscal, trade and immigration policy. If Trump returns to the presidency, we could see a resumption of his combative approach on trade. A strong market reaction to protectionism and tariff risks, which is inflationary, is possible if there is a shift towards viewing some of the dramatic tariff proposals as less of a gambit and more of a concrete policy plan. Trump has at times mentioned the possibility of a 60% tariff on Chinese goods, as well as a 10% tariff across the board on US imports.
The US presidential election in November is still almost six months away. But with the first debate scheduled to take place on 27 June, market focus could pick up well ahead of that point.
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