Light Trading on Midterms

MACRO FRAME

Investors are rotating out of tech as a Q3 earnings reflect sharp drops in free cash flow. Recent price action suggests a repricing of the AI trade rather than a deterioration in macroeconomic sentiment.

STOCK INDEX FUTURES

Equity index futures were mixed overnight, with the Dow lagging the S&P and Nasdaq ahead of midterm elections in the US. Traders are seemingly unwilling to take positions in the Dow, which has broad exposure to financials, healthcare, and the industrials sectors. The tech space is finding relief despite ok results from Apple and Palantir ahead of AMD’s quarterly results tonight, which will act as a bellwether for memory demand and outlook. Results from Super Mirco, Amgen, and Occidental will also be closely watched. Election day is likely to bring lighter-than-usual trading volume. Lower oil prices continue to offer some relief to US equities, but technology is likely to remain under pressure as investors reassess valuations, earnings prospects and financing needs. Oracle fell more than 8% on Monday after announcing plans to raise $20 billion through debt and equity issuance, while Apple’s subsequent earnings outlook added to concerns about rising costs across the sector. Technology’s correction has brought valuations closer to historical reference points, but the durability of that support depends on earnings expectations. Applying the tech sector’s October 2022 forward multiple to current earnings forecasts would imply roughly 2% additional downside, while matching the average decline of earlier corrections in this bull market would suggest around 8%. With forward earnings estimates up approximately 17% over the past three months, revisions remain a key risk.

CURRENCIES

US DOLLAR: The USD index is little changed at 101.765. A further drop in oil prices is pressuring the dollar, though election uncertainty is largely keeping moves constrained. The October ISM manufacturing PMI rose to 55.5 from 54.5, pointing to firmer activity, while elevated input prices complicated the inflation outlook. The combination leaves the dollar facing competing influences from resilient US growth, persistent cost pressures and geopolitical uncertainty. October’s nonfarm payrolls data (63k est.) will help shape the narrative around Fed policy, though ultimately inflation data offers the best guidance on how the Fed will act on rates. December rate hike odds are priced at 75%.

EURO: The euro is little changed at $1.1193 as traders await clarity on US elections and US-Iran diplomacy. Lower oil prices provide a more favorable energy-cost backdrop, but uncertainty over a potential agreement is limiting confidence in sustained relief. The ECB’s hawkish hold and forward guidance has all but guaranteed a rate hike at the bank’s meeting in December. The euro’s upside, however, is likely to be contained by the prospect that December’s rate hike will be followed by a pause. ECB estimates circulated ahead of the meeting suggested that higher bond yields would cumulatively lower growth by 1% and inflation by 0.9% over 2027–28 relative to September’s baseline projections. The implication for the euro is that additional tightening beyond a December hike raises downside risks to the medium-term growth outlook. Additionally, higher yields across the currency-bloc have already tightened financial conditions, reducing the need for additional tightening from the ECB. French fiscal and bond market stress will also continue to act as a headwind ahead of the French presidential election. Fitch revised their outlook for France to negative, suggesting that fiscal risks remain front and center. Money market expectations are pricing a 66% chance of a hike in December and 56 bps of tightening over the next 12 months.

BRITISH POUND: Sterling is little changed at $1.3419, as traders await US election results ahead of the Bank of England’s policy meeting on Thursday, where it is expected to raise rates. Money market pricing of 100 bps of tightening by year-end 2027 is excessive and leaves the currency vulnerable to a pullback in those expectations. With the government’s recent budget announcement offering no surprises, price direction in the pound will be more reflective of BoE expectations and the Sterling’s relative strength over the euro. While the UK economy has shown resilience over recent months, the bank will likely remain cautious against future rate hikes to avoid slowing its fragile growth backdrop. Elsewhere, falling oil prices and hopes of a resolution to US-Iran hostilities will be supportive of the currency.

JAPANESE YEN: The yen fell 0.15% to 158.18 yen per dollar. US election uncertainty, Gulf diplomacy and broad  weakness in technology shares form the broader backdrop. Underlying inflation has hit levels consistent with the bank’s 2% price target, which should open the door to future rate hikes from the BOJ. Money markets are nearly fully-priced for a rate hike in January and see 67 bps of tightening over the next 12 months. With the bank now cautious about overshooting its inflation target, it could potentially speed up the rate of hike from roughly every six months to every three months, leaving the door open for a hike at the December meeting. The BOJ characterized financial conditions as accommodative, though the pace of future hikes ultimately depends on upcoming data.

AUSTRALIAN DOLLAR: The Aussie is down 0.20% to $0.6981. The Reserve Bank of Australia hiked rates 25 bps in a split 6-3 decision and removed language explicitly stating its willingness to raise rates further if necessary in its policy statement. Signaling an end to its hiking cycle. Market-implied odds of another increase to 5.10% fell to roughly 24% from 40% before the announcement.

TREASURY FUTURES

Yields inched higher across the curve alongside the drop in oil prices and as investors await US election results. October’s ISM manufacturing PMI increased to 55.5 from 54.5, while input prices remained elevated. That combination points to firmer activity without relief from manufacturing cost pressures, a dynamic that continues to argue for higher rates over the coming months. Friday’s payrolls will be central to determining whether labor-market resilience continues to justify another increase. September’s PCE argues against the narrative that the Fed can remain on hold.  Warsh did imply a hesitancy to raising rates higher, saying “the goal isn’t to throw sand in the gears of the economy and throw people out of work,” implying the Fed does not want to raise rates enough to actually slow the economy. This may reflect a slower pace of future tightening than what the market has/had priced in. However, upcoming data will ultimately be the factor that shapes the trajectory of Fed policy. If growth and inflation continue to grow, while labor conditions remain steady the Fed will likely need to raise rates by 50 bps over the coming 12 months. However, if the data proves accommodative, the market could experience a curve-steepening, reflected by a drop in short-term rates. Near-term risks to the Fed raising rates are in the form of a divided government post-midterms that results in a debt-ceiling gridlock, while the geopolitical risk of renewed US-Iran strikes complicates the oil trajectory. These conditions would add to volatility in the market that may result in the Fed want to remain on hold to avoid adding further stress to the market.

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