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US Election, The Driver, Week Ahead, Macroeconomics, fx trader, forex

The second important instrument that is telling us investors think a Trump victory is unlikely is the December Fed funds futures strip. The hypothesis is new of a Trump presidency would roil the markets. This market volatility would likely reduce the chances of a Fed hike next month. If one thought that Trump would win, the peso would be lower, and the Fed funds futures would not be so steady.

For the last 12 sessions, the December Fed funds futures have been closing between 49.5 bp and 50.5 bp and recall that the bid-spread offer is half a basis point. Bloomberg calculates this to be a 76% chance of a hike, while the CME estimates the odds at 66%.

Our own work is in line with Bloomberg's estimate.  Recall the futures contract settles at the average effective Fed funds rate for the month. What will the be that average in December?

For the first 14 days, let's assume Fed funds averages what it has been in recent weeks, 41 bp. Let's assume the Fed hikes on December 14, and on December 15, Fed funds average the midpoint of the new range (50-75 bp) of 63 bp. However, due to the quarter and year-end, the Fed funds rate will likely fall on Friday, December 30. The Friday rate applies to Saturday, December 31 as well. A reasonable and conservative estimate is that the effective average will slip 15 bp to 48 bp.

Add those products together (14*41)+(15*63)+(2*48) and divide by the 31 days of the month, (49.5 bp). The December Fed funds futures contract has discounted 76.5% of 25 bp hike in the target range.

Part of the challenge for investors is a misunderstanding about polls in general, and the narrative frequently told around the Scottish and UK referendums. The polls were wrong, we are told, so polls are not helpful. This is not true. In Scotland, most of the polls done for partisan interest found the results they were looking for, but the properly conduct fair polls showed the referendum was going to lose.

In the UK, the last dozen polls or so showed a close contest. The markets, including those like myself who saw the murder of the UK MP as a cathartic event that would offset the poorly run campaign of the Remain camp got it wrong. The betting shops got it wrong as some large bets for Remain overwhelmed the most numerous bets favoring Brexit. Ironically, the polls seemed to have gotten it more right than the gamblers and traders.

There is a divergence in the poll analysis in the US that has become pronounced since the FBI's announcement on October 27 about the new development about Clinton's emails. Some, including Fivethirtyeight.com, and RealClearPolitics see the race as having tightened considerably. The former has Clinton as favored 65.5% chance of winning, after peaking near 88% a couple of days before the third debate. The latter has Clinton ahead by 1.8 percentage points in a survey of national polls. The Financial Times caught this spirit in the headline of its weekend edition: "US election knife-edge as rivals weigh early-voting data."

Their calculations of how the electoral college may breakdown, both put Trump less than 30 electoral college votes shy. That means that one large state, like Florida (which fivethirtyeight.com has leaned toward Trump and RealClearPolitics have favoring Clinton by 1.2 percentage points) can give deliver Trump a victory.

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