It is becoming ever clearer that from September and into year-end traders of all asset classes are going to have to face the challenge of bridging the link between political outcomes and the future economic impact. Then, from here linking these outcomes back to financial markets. 
Some will relish the fact that bond and FX markets will be far more beholden to political news flow, but as the numerous case studies have shown over the past six years or so, traders are fairly poor at pricing and trading political events. Take the Trump presidential victory for example. Many will claim that they predicted Trump in the White House, but few would have prophesied the extreme reaction in financial markets when he gave his inaugural speech. We tend to get emotional, think irrationally and overreact and while this creates opportunity, it also means having to contend with heightened noise.
While it is so hard to do, turning away from the headlines and adopting a far greater weighting to price action and the technical set-ups would undeniably improve a trader’s edge, not to mention retain their sanity.
So, as we roll into the business end of the calendar year, we can see key political events in the UK, with the Brexit negotiations and two key EU summits affecting the GBP. We have the Italian 2019 budget negotiations starting in September, the US mid-terms on 6 November, as well as Trump’s trade representative’s decision on applying a further $200b of tariffs on China’s exports in September. And as things evolve, we are also looking set for an election in Australia, potentially in October. We are all political commentators from here, with so many G10 currencies partially moving away from being driven by cyclical to political forces and that means volatility. 
The USD will clearly be central to everything, so the 6 November US mid-term elections will garner even more attention and the last 48 hours, the news flow around Paul Manafort and Michael Cohen, will not have done Donald Trump any favours in either his ability to control trade talks with China or Mexico. Or, the Republicans representation in the House and the Democrats are heavily favoured to reclaim this chamber. Its hard to see this as a USD positive as we then start to talk about gridlock in Congress. 
That said, after six consecutive days of USD declines we have seen the USD reversing course and closing +0.5%, with gains seen against all G10 currencies, with even more noticeable gains seen against EM currencies, such as the BRL, ZAR and MXN. There doesn’t seem to be one clear red flag for the strength given the US data in the form of new homes sales and Markit PMI both missed expectations. However, we also saw uninspiring economic data in Europe, with Eurozone manufacturing PMI printing 54.6 relative to expectations of 55.2, while consumer confidence fell to -1.9 (the three-month average sits at -0.3). 
EURUSD was offered from the start of Asian trade, with price falling from $1.1600 into $1.1530 and perhaps this reflects trader’s squaring up USD exposures ahead of Fed chair Powell’s speech at Jackson Hole tonight. Some have focused on an FT article highlighting that Angela Merkel is favouring a German at the helm of the European Commission and less so at the ECB, which is an interesting view as the hawkish Jens Weidman had been seen as a key candidate to replace Mario Draghi. This story will require further attention.
Political gridlock may be something that could be a frustration for Trump after the mid-terms, but it is a theme that Australian voters know only too well and that dynamic is one of many factors hitting the AUD in the past 24-hours. There are few buyers out there supporting the ‘Aussie’ here, and the cross-currents almost make for a perfect storm for AUD deprecation. Interestingly, the interest rates market doesn’t see this these political issues as having a bearing on future RBA policy, with 11.5bp of hikes still priced in through end-2019 and there has been no real movement in 3-year Aussie bonds. 
In G10 FX, AUD is ultimately lower against currencies and the 1.4% drawdown in AUDUSD is the largest one-day fall since May 2017, and while the sell-down looks stretched here, the market has the December 2016 lows of $0.7160 in its sights. On the day, I am happy to sell any rallies in the pair. 
Long EURAUD was my tactical and technical play yesterday, and the daily chart looks progressively more bullish here, with price smashing through both the April downtrend and June/July highs at 1.5882. Pullbacks are a buying opportunity in my opinion, as this pair should trade into 1.6000 in the short-term. GBPAUD is another pair to watch in the battle of the political currencies, and at this juncture, GBP is the better long, although my preference is EURAUD here. 
The news flow coming from Canberra is keeping traders away from the AUD, and when the bid dries up, and sellers are prevalent, we can often see punchy and exaggerated moves. The news flow will continue to roll in today with another leadership challenge likely to be called. Betting markets still have Labor firmly as taking the lower house, but the issue of how policy is passed through the Senate suggests the passing of any future legislation could be a real issue, similar in many ways to that of the US after the mid-terms. This has to be an AUD negative, as the ability for Labor to address the deficit and raise taxes by A$223b over 10-years will diminish. The views around Australia’s AAA-credit rating from the likes of S&P and Moody’s in the wake of the election is going to be a market mover.
Politics aside, moves in EM have resonated in the AUD, especially with USDCNH finding buyers easy to come by and as we have seen of late, USDCNH up, AUDUSD down. USDCNH could be the bigger driver of markets in the session ahead.
Australia 2,5 &10 yr yield (total) – US 2,5 & 10 treasury yields
(Source: Bloomberg)
Published by Chris Weston, Head of Research, Pepperstone