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September Election Intrigue - Global Exchanges

FICC Podcasts 25 août 2021
FICC Podcasts 25 août 2021


Disponible en anglais seulement

In this week’s episode we discuss the potential FX market implications of two big elections coming up in September: the German four-yearly federal election and the snap Canadian federal election.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

Podcast Disclaimer

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Disponible en anglais seulement

Greg Anderson :

Hi, welcome to episode 18 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. In this week's episode, my cohost Stephen Gallo, and I will discuss the potential market implications of two big elections upcoming in September, the German federal election and the Canadian federal election. The title for this episode is September election intrigue.

Stephen Gallo :

Hi, I'm Stephen Gallo, a London-based FX strategist. Welcome to Global Exchanges, presented by BMO Capital Markets.

Greg Anderson :

Hi, I'm Greg Anderson, a New York based FX strategist. I'm Stephen's cohost.

Stephen Gallo :

In each weekly podcast like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets like commodities.

Greg Anderson :

We strive to make this show as interactive as possible. So don't hesitate to reach out by going to bmocm.com/globalexchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO Capital Markets, it's affiliates or subsidiaries.

Stephen Gallo :

All right, Mr. Anderson. So we're just going to take a quick look at where we are right now. It's August 24th and the lazy days of summer are rapidly drawing to a close. One of the recurring themes in our recent podcasts has been the very tight ranges in FX markets. I've considered them fairly brutal to watch, but in light of that, what we've been doing is looking for potential market movers or market drivers. And this week we've got reasons to look towards the political sphere on both sides of the Atlantic. And I think we're doing that for a couple of reasons, firstly, because it's nearly September and we've got a snap election in Canada set for September 20th. And then just after that, Germany goes to its regularly scheduled four yearly lower house election on September 26. But the other reason we're looking at this now is we started to field questions from other participants in the market. I know you have, I have. So there's intrigue building, questions are accumulating. So with that in mind, where do you want to start with this topic today Greg?

Greg Anderson :

Stephen, I think I'll start with a disclaimer if that's okay. Part one of the disclaimer is that the views expressed are Greg's and Stephen's and don't necessarily represent any kind of a BMO institutional view. Part two, is that we are FX strategists, not political scientists. And part three, is the admission that I'm an American talking about Canadian politics. So I don't have the depth of emotion and knowledge of a local on some aspects of the Canadian election. And likewise Stephen, you're an American talking about German politics. And while that may reduce some of the biases that are inherent with having a personal stake in an election outcome, it also tends to mean that you have less of a historical background than a local. Now with all of that out of the way, if it's okay by you, I want to start by talking about the German election. How about if I just start asking you some market relevant questions about it?

Stephen Gallo :

Well, first of, Greg, I'm not surprised at all that after me living in the UK for nearly 20 years, you can still tell that I'm an American LOL, but yeah, on a serious note, I second all of that, Greg, including the disclaimer. So with that in mind, let's throw some questions at each other.

Greg Anderson :

My first question Stephen, is about how important you think the election is to the Eurodollar exchange rate? On a scale of one to 10, with one being a complete non-event and 10 being the biggest event of the past several years, where would you rate the German election upcoming on September 26th?

Stephen Gallo :

Well, you know what, Greg, I'm going to give you two answers. One score that I'm going to give you is going to be based on the significance of this election as a milestone in German politics. And that's because with Merkel departing the scene, she's been there for a decade and a half more or less, with her departing the scene and millions of people in both Germany and the financial markets, not really knowing what this means for the future of Europe's largest economy, I give this election a seven. But in terms of Eurodollar impact, although elections always have outlier risks that we need to be aware of, I'm going to give this election as a base case, a pretty low score of four. And here are my rationales for this. First of all, politics tend to be consensus based in Germany. And most of the time the results don't reflect radical departures from the center, the center ground in politics, that of course has a historical component to it, which I'm sure I don't need to go into. But secondly, Germany system uses a combination of plurality voting and proportional representation.

Stephen Gallo :

And so the potential for votes to be split and of course the allocation of seats under the PR system means you end up with results that are, as I say, sometimes diluted or some might say muddled. So the third reason I'm giving this election a score of four is the uncertainty factor. As I've said already, Merkel's departing, what does that mean? We don't really know. So therefore we can't really trade it. And additionally, you just got to look at the current party list poll averages for PR voting only. Right now, there are three key parties, the CDU, CSU, the Greens, and the SPD. They're all polling around 20%. And in fourth place, you've got the free Democrats pulling out a little under 15%. So the likelihood is that we're looking at a three party split in German government after the elections. I think for these reasons I give this election a four.

Greg Anderson :

Next question, Stephen, have there been any recent developments over the last couple of weeks, say that have either moved Eurodollar or that maybe should have moved Eurodollar, but didn't because we were too distracted by the mini taper tantrum in the US?

Stephen Gallo :

You know what I would say, Greg, only in the sense that FX markets have started to price in, or at least grown to understand that we may not have a clear result on day one after the election and possibly as well that the formation in running of a government could be pretty tricky.

Greg Anderson :

On the topic of timing, it's my observation across nearly 25 years of doing this, that different countries have different intervals in terms of when market participants really start trading the election. In some places it's only a few days prior, but in others, there is a key pre event a month or more out kind of like maybe a televised debate or something. So with this German election and with the date of the election being September 26th, when do you think it starts driving Eurodollar? And to follow up, you mentioned the trickiness of forming a government. When will we actually know what the election result is? And when will we know who the chancellor is and who gets all the key economics related appointments?

Stephen Gallo :

So Greg, as I've mentioned already, I think there's been a modest pre-election sort of price action in Eurodollar on the basis of there being a less than clear results or a projected period of time during which a government will need to be formed after the election on September 26. This isn't a particularly new situation for German politics. After the 2017 election, it took until the following March for a new government to assume the leavers of power. And if you look at the price action in Eurodollar over the interim period, you can sort of make out the extent to which Euro appreciation was held back by the length of time it took to formulate a coalition. But here's the important thing. At the time and at the moment, I think this is likely to be the case during the current election cycle.

Stephen Gallo :

The FX market was really only trading the uncertainty factor. They weren't really trading clear policy shifts. So here's what I'm going to give you. As long as the polls don't suggest that an outlier response becomes the base case between now and September 26, I think markets are just left to trade the uncertainty factor related to the formation of a government. And the most important trading period for Eurodollar is likely to be in the two to three days immediately after the result. If it looks like there'll be months of horse trading and negotiations ahead of us, then I think there's room for Eurodollar to drift a bit lower or at least room for the Euro to underperform it's G10 and EM peers. On the other hand, if a path to a three-party or even a two party coalition looks likely to be smooth and quick, then I think the pair can drift higher. And some of that uncertainty risk discount comes out of the Euro.

Greg Anderson :

So, Stephen, my next question, and next to last question is, is there a major Euro bearish surprise that we should watch out for? And along with that, what probability would you personally assign that surprise? And in percentage terms, how much do you think that might move Eurodollar lower?

Stephen Gallo :

You know what, Greg, I really don't think so. The most bearish or Euro bearish thing I can think of apart from the far right being in a spot to be part of a coalition government, is that the right leaning CDU, CSU significantly increase its share of the vote relative to where they are now in the polls and relative to where they polled in 2017. So if we unexpectedly see them pulling upwards of say 30% in that case, I think the FX market and probably the bond market for that matter will be more likely to price in a quick return to fiscal consolidation and balanced budgets. But so far the polls currently suggest that a more expansionary fiscal policy in Germany will remain in place for a while under the likely coalition scenarios. The question mark, I would just assign to that is how much of an expansionary fiscal policy?

Greg Anderson :

Thanks for that, Stephen. So my last question, is there a substantially Euro bullish surprise that we should watch out for? And what probability would you assign it and what percentage impact might it have?

Stephen Gallo :

I don't think there's a clear or simple answer on this one, either Greg, at least as far as my non German American mind can tell. But I think based on current polling, the main outlier scenario we need to monitor for this election is a definitive shift to the left in German politics, where it becomes, for example, a foregone conclusion that Germany will have a three-party government involving the SPD, the Greens, and Die Linke, which is a radical left party currently polling around 7% or just above the 5% threshold needed to have seats in the lower house.

Stephen Gallo :

I'm going to give you at this stage a three-way split of this nature of 15% probability. And I would tell you that it's probably short term Euro bullish on an order of magnitude of about one to do big figures in Eurodollar, but medium term Euro bearish. And I'm basing that on the fact that I think that there could be a backup in German yields on this result, which would initially support the Euro. But I think it would be followed up by concerns over Germany's role as an anchor country for the rest of the Euro zone. If we somehow end up as an alternative scenario with a two-way between the SBD and the Greens, I think that reaction would be similar to the one I just described, but the price action would be smaller.

Greg Anderson :

Hey, Stephen, I think that concludes my questions on the German election. What do you want to ask me about the Canadian election?

Stephen Gallo :

Greg, I intend to use broadly the same playbook as you did with your questions for my line of questioning. So my first question is how do you rank the importance of this election on a scale of one to 10 for market impact in dollar candidate?

Greg Anderson :

Stephen, I think this one is only about a two or three, and just for reference, I would put Trump versus Biden last year as a nine, and then the 2015 Canadian election where we swung fairly hard on fiscal and environmental policies in Canada with the transition from Harper to Justin Trudeau, I put that as something like an ex post eight.

Greg Anderson :

At any rate, one reason I would rank this 2021 election so low is that we don't have a ton of policy space between the conservatives and liberals. I would argue that it's not nearly as big of a space as in the past. And it's nowhere near the gap between Republicans and Democrats in the US. And then as another quick aside, this election is on Monday, the 20th of September, and we have two days later on Wednesday the 22nd, what should be a fairly monumental FOMC. So to the extent that speculators might want to trade the Canadian election as a theme, they really can't. It's just too hard to thread the needle. So I think the main impact that we might see on dollar Canada is strictly via hedgers rather than traders.

Stephen Gallo :

Nice one Greg. So my next question, sticking broadly to the playbook you used is, have there been any noteworthy recent developments that have moved dollar Canada or should have moved, dollar Canada?

Greg Anderson :

Stephen, the possibility of a snap election has been sort of hanging over us all year, but it was always a bit unclear when, or if Trudeau might do that. He ended up doing so nine days ago. So I'll call that a recent development. Another development I'll point out is that the one month settlement date for dollar Canada forward and option contracts rolled past the election last Friday, and perhaps not coincidentally Canadian dollar had an exceptionally bad day, both against the US dollar and also on crosses. So that's recent development number two. Then the last thing, I would just say the opinion polls that have come out since the snap election was called, have not been nearly as good for Trudeau and the liberals that they probably thought they would be.

Stephen Gallo :

All right, Greg. Then question number three, are there any key dates between now and September 20th that could have a market impact on dollar Canada? And when will we know the results?

Greg Anderson :

Stephen, there are three televised debates on the docket. The first one on September 2nd is in French. I think it will probably be treated both by candidates and markets as sort of a practice run. But then we have another French language debate on September 8th and then an English debate following it on September 9th. I think those two debates might conceivably shift election odds and move dollar Canada a little bit. In terms of when we will know, we could know within a few hours. That has generally been the case in the past in Canada, at least that we can project how the vast majority of writings will turn out. And that is usually enough to project the whole election.

Greg Anderson :

If it turns out that the election is so close that the outcome hinges on just a few seats, then the fact that mail-in ballots will be so common this year might slow things down to the point where we won't know for a few days. All in all, I would say that it's likely that we'll know by the 10 o'clock Eastern daylight time, New York cut options expiry on Tuesday, September 21st, but it's certainly not guaranteed this time around.

Stephen Gallo :

Okay, Greg, we'll be looking out for all of those developments for sure. Onto my penultimate question number four, are there any clear CAD bearish results, do you think that we need to be watching out for as a result of the upcoming election?

Greg Anderson :

Yeah. Stephen, let me first repeat our disclaimer. These are my views and don't represent BMO's institutional views or political positions in any way. But I would say that the most bearish result that is reasonably possible is the liberals losing seats to the NDP. As it stands now, while Trudeau presides over a minority government, it's an easy to manage minority in that he just needs to attract half of the BQ or half of the NDP, to pass things. That hasn't been a problem. But if we were to end up in a situation where he needed all the MP's from either the NDP or the BQ to pass things, then that loss of leverage would be a bit of an unstable result. Therefore, that outcome might bother global investors. And I presume that the political uncertainty would be bad for the Canadian dollar. Right now, things aren't exactly trending that way because the opinion surveys are showing that liberals are losing a bit of support to the conservatives, not the NDP, but this scenario is still merits watching over the next few weeks.

Stephen Gallo :

All right, Greg. So for the final question, we move on to the bullish scenario. Are there any clear CAD bullish results we need to be watching?

Greg Anderson :

Before identifying the most CAD bullish scenario, let me give my view about the conservatives winning scenario. While that would presumably lead to tighter fiscal policy and less stringent environmental policy, I don't think it would necessarily lead to CAD strength. In my experience, global investors prefer the certainty offered by incumbents over almost any set of policy promises. That said, if we end up with a result where the conservatives have gained seats while the NDP and BQ have lost seats, but Trudeau is still the prime minister because the liberals still have the biggest minority of seats, then we may end up with a situation where Trudeau ends up needing to work with centrist conservatives to an extent that he hasn't needed to thus far.

Greg Anderson :

In that scenario, it might end up looking more like a national unity government that looks reasonably stable and also looks too constrained to do anything policy-wise. Markets might like that and push CAD a bit higher over the medium term, but I'm not sure we would get more than 1% say, over the short term. That's not very exciting, but I will reiterate that I also think that just the passing of the election related event risk might give us something like a half percent of 1% worth of CAD strength. I'll just reiterate that we saw about a half percent to 1% negative bubble for the Canadian dollar relative to other financial prices on August 20th. That could easily unwind in the September 21st to September 22nd window if one month hedges that were initiated in August 20th, don't get renewed.

Stephen Gallo :

I think we should wrap things up at this point, Greg. At least we have some intrigue to monitor as we head towards the final third of the year. Thanks again to all our listeners until next time.

Greg Anderson :

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at bmocm.com/globalexchanges.

Stephen Gallo :

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple podcasts, Spotify, or your favorite podcast provider.

Greg Anderson :

This show and resources are supported by our team here at BMO, including the FICC Macro Strategy Group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

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Greg Anderson Chef mondial, Stratégie de change
Stephen Gallo Chef de la stratégie de change pour l’Europe

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