Three Major Market Drivers

October 3, 2016

At the very end of September and the third quarter of 2016, with the US Federal Reserve’s latest interest rate decision out of the way for the time being, three major drivers have been dominating the financial markets and should continue to be instrumental in moving markets going forward. These three drivers are: 1) the first US presidential debate and upcoming elections, 2) severe troubles in the banking industry, and 3) the oil production deal reportedly agreed upon by OPEC members this past week.

1) US presidential debate and elections - Coming up in less than six weeks, the US presidential elections could have extensive implications for equities, currencies, and commodities, among other markets. There has been a strong consensus that Clinton won the first presidential debate this past week, which has generally been good news for equities. On the whole, markets currently tend to fear a Trump victory due to Trump’s unpredictability and his potentially dubious positions on global and domestic economic issues, and would therefore be much more welcoming of a Clinton victory, at least initially.

Over time, however, it remains to be seen how markets would react to each candidate as President. Although Trump is generally seen as much more friendly to big business and Wall Street with his support for corporate tax cuts and financial deregulation, his broader economic policies remain uncertain to some and quite problematic for others. This is especially with regard to his highly protectionist trade policies and the probability of a more rapidly rising deficit under a Trump Administration. Meanwhile, although Clinton is the status quo, establishment candidate who makes markets much less nervous, she also supports high corporate taxes, penalties, and increased overall financial regulations, which could be a significant negative for equities in the longer run.

With respect to currencies, Trump has established his monetary outlook as more hawkish-leaning after his repeated criticisms of Yellen and the Fed for keeping rates low and creating a "false stock market" for political reasons. Therefore, he will likely attempt to influence the Fed towards the hawkish side, which could eventually boost the dollar further. In addition, as Trump has often touted his protectionist trade policies, the dollar may strengthen against emerging market currencies like the Mexican peso and Chinese yuan under Trump. Because of his well-known support for Russian President Vladimir Putin, however, the Russian ruble may see a boost if Trump is victorious in November. Clinton, in contrast, appears more dovish and would likely keep the status quo for the Fed intact, which may mean "lower-for-longer" interest rates and a ceiling on the dollar. Additionally, if Clinton is victorious, Trump obviously will not be, so emerging market currencies like the Mexican peso and Chinese yuan could see a rebound.

As for energy markets, Trump has expressed his goals to deregulate oil production and increase capacity, which could weigh on crude oil prices if Trump gets his way. In contrast, Clinton is determined to shift substantially towards solar and other renewable energy, which would lower US oil production and could lead to a subsequent rise in oil prices.

2) The banking industry has had a rough week, to say the least. The US Justice Department has demanded that Deutsche Bank, the largest German bank, pay fines amounting to around $14 billion related to past mortgage-lending practices. This quickly highlighted troubles surrounding the German behemoth. Reports on Thursday that some hedge funds were limiting their exposure to Deutsche Bank sent its already-depressed stock plunging further, taking the broader stock market down with it. This resulted in a modest boost for safe haven assets like the Japanese yen and gold. Although both Deutsche Bank’s stock and the broader US markets quickly recovered on Friday, the risk of further troubles for the bank remains as speculation continues over the possibility of a bailout by the German government or European Central Bank.

To make matters even worse for the banking industry, Wells Fargo, the US banking giant, has recently been under investigation for a massive scandal involving dubious sales and business practices. These revelations have pummeled the stock, which has brought it down to new long-term lows this past week, further weighing on financial stocks.

3) Finally, the reported oil production deal struck in Algeria by OPEC members this week has led to a sharp rally for crude oil, which has also helped provide some support to equity markets. The sustainability of this rally, however, will depend largely on the details of the deal that should be revealed by the next OPEC meeting in November. Though members agreed to cut oil production collectively down to 32.5-33 barrels per day, specific quotas for each member have not yet been determined or revealed. Furthermore, even if such a deal is struck, it remains to be seen if or how long members may abide by it, given OPEC members’ long-standing political and economic rivalries and differences. Another big question also remains as to whether any OPEC production cut will have much of an effect on oil supplies globally, as non-OPEC members, like the US, may simply increase production to gain additional market share. In the end, crude oil prices may just continue to consolidate or even fall significantly further after the initial optimism over the proposed OPEC deal dissipates, and reality sets in.

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