Weekly Preview - Surge In Volatility Following U.S. Election

 |  Includes: DIA, QQQ, SPY, VGK
by: Tim Clayton

Vital US and international policy areas have been deadlocked ahead of the US Presidential and Congressional elections. Following Tuesday's vote the political logjam will be released and markets can expect a surge in volatility as risk premiums move to reflect a more sobering reality. The most likely outcome is a much more defensive tone and a stronger dollar, especially as the Euro-zone again threatens to implode over Greece. Market complacency over narrow forex ranges is also likely to be shattered, especially with concerns that liquidity levels have been seriously compromised.

The one outcome which would destabilise US markets is where there is no known Presidential result for days or weeks. In the notorious hanging-chad Florida drama of 2000, the Supreme Court ruling which finally decided the outcome was not made until December 13th. Given the closeness of 2012 polls, there will be fears of another very close and disputed state vote with Ohio the most likely culprit this time around. Equity markets would be likely to take a prolonged delay extremely badly and, although US confidence would be wounded, the deterioration in risk appetite would certainly boost defensive dollar demand with net US gains.

Opinion polls point to a broadly tied vote nationally with Obama holding an important edge in the electoral college. The most likely outcome is for Obama to again win a second term and again face a divided Congress which will make for extremely tough budget negotiations as the US faces crucial fiscal decisions at the start of 2013. If Romney were to pull out a surprise victory, uncertainty over Fed policy would rise substantially.

Even if US political uncertainty is reduced, there will be an offsetting surge in uncertainty elsewhere in the global economy. No matter how hard markets and politicians attempt to distance themselves from Greece, the issue simply will not go away and this week there will again be the drama of brinkmanship and talk of government collapse.

Parliament is due to vote on the package of troika-demanded austerity measures on Wednesday with a 2013 budget vote due on Sunday. The coalition remains divided over austerity measures with Democratic Left still threatening to vote against labour-market reforms. In theory, New Democracy and PASOK have a majority to pass the measures, but some MPs will certainly oppose the measures and party whips will have a very tough task keeping control. Rejection would plunge Greece and the Euro-zone into fresh instability as the pretense that current policies have any credibility would be shattered with the Euro under renewed pressure.

The US administration exerted huge pressure on the IMF, Germany and Euro-zone as a whole to avoid a Greek showdown ahead of the Presidential poll. The Greek government will certainly be feeling very exposed following Tuesday's US vote and the Spanish administration will also be under intense pressure with 'core' countries showing their true colours following the US vote and German euro-skepticism would be off the leash once again.

China's 18th party congress, which is due to start on November 8th, will elect a new central committee and confirm the next President. The PBOC has clearly been pushing for a stronger yuan ahead of the US presidential election with the move seen as attempting to undermine Romney's accusations of China as a currency manipulator and help the Obama campaign. This policy is likely to be reversed this week with China looking at export competitiveness as the more pressing issue. If Romney were to win the presidency, trade tensions with China would escalate very rapidly and Japan's currency policies would also be under much closer scrutiny.

Interest rate decisions will certainly play an important role during the week, especially as there is a much higher degree of uncertainty than in previous set pieces. First up will be the Reserve Bank of Australia interest rate decision on Tuesday. Early last week there was close to unanimity in expecting that the central bank would cut interest rates, but there have been greater doubts over the past few days with some analysts expecting the bank to keep rates on hold at this meeting and a cut would trigger substantial Australian dollar selling.

The ECB will announce its latest monetary policy decision on Thursday with the central bank still in limbo given Spain's refusal to request a bailout which has kept the bond-buying plans on ice. There is very little cause for optimism with the economy continuing to contract at the aggregate level while the peripheral outlook remains grim. Although the monetary aggregates suggest that the policy easing earlier in 2012 has had some positive impact, there will be pressure for the ECB to embark on yet another journey into unknown territory with negative deposit rates. Tuesday's Euro-zone PMI services data will be watched very closely with Italy and Spain a key focus.

The Bank of England will announce its latest interest rate decision on Thursday with the latest round of bond purchases due to be completed on November. The Monetary Policy Committee will, therefore, have to decide whether to launch a new round of quantitative easing.

Expectations of further quantitative easing dipped sharply following the stronger than expected third-quarter GDP data, but there have been renewed doubts following the PMI manufacturing data. There is certainly a high risk that there will be a split decision among the nine-man committee with divided expectations also sure to trigger a substantial market reaction.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.