Trading The US Elections
EUR/USD, USD/JPY: All Hinges On Clinton Versus Trump: Levels To Watch
The euro has strengthened against the US dollar over the last week rising back above the 1.1000-level. It has been mainly driven by a weakening of the US dollar in the run up to the US Presidential election on the 8th November. The latest opinion polls have revealed that Hillary Clinton’s lead has continued to narrow following the re-opening of the FBI probe. It has prompted the market to price in more of a political risk premium into the US dollar to reflect the higher likelihood of Donald Trump becoming President. Still at the current juncture it appears likely that Hillary Clinton will become President which remains our base case scenario.
A victory for Hillary Clinton would result in the US dollar rebounding in the week ahead as the focus switches back to Fed policy.In contrast, a shock victory for Donald Trump could trigger a sharp US dollar sell off potentially delaying the resumption of Fed rate hikes.
USD/JPY – NEUTRAL BIAS – (100.50-104.00)
USD has been weakening, hit by the FBI investigation right before the US presidential election. The November BoJ and FOMC meetings this week did not result in any surprises. USD strengthening pressure has been diminishing.
Japanese investors are unlikely to make any big moves ahead of US Elections. The recent drop in oil prices may push USD/JPY lower.
If Clinton wins next week, USD may return to the recent high, but no stronger. If Trump wins, the surprise could cause USD/JPY to fall below the lower bound 100.50.
FX Market's Favorite Election Indicator Is Relatively Sanguine
As we noted over a month ago, the Mexican peso has become the FX market's de facto measure of "Trump" risk. Traders view Republican Presidential candidate Donald Trump as being relatively hostile to Mexico, given his promise to build a wall along the US-Mexico border and his harsh opposition to the North American Free Trade Agreement ("the worst trade deal the US has ever signed").
Therefore, when Trump's odds of winning the presidency have risen, the peso has tended to struggle (USD/MXN rises) and conversely, when Democratic candidate Hillary Clinton's probability of taking the oath of office has ticked up, the peso has seen a relief rally (USD/MXN drops). Interestingly, this previously reliable relationship has broken down of late.
Trump's odds, as measured by poll aggregators like RealClearPolitics and FiveThirtyEight, are at multi-month highs. However, the peso is not at corresponding multi-month lows. In fact, the peso has strengthened notably over the last several days in particular, and the currency is now trading around the midpoint of its 6-month range at 19.00.
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Markets Await US Presidential Results
It has been the most controversial campaign in the American history - and now after all the scandals, rumors, investigations and mostly an unpleasant elections race - it's almost over.In two days, we will know whether America has decided to elect Donald Trump or Hillary Clinton to replace Barack Obama as the 45th President of the United States.
Although Democratic US presidential candidate Hillary Clinton holds a five-point lead over Republican Donald Trump in the latest Washington Post-ABC Tracking Poll released early on Sunday, a change over to Trump's side is still a possibility.
Despite Trump's attempts to manipulate polls numbers, it is most likely that Hillary Clinton will win US elections on Wednesday. According to most predictable scenarios, the democratic candidate will win 270 electors which is the minimum number required to win US elections. The 'New York Times' concluded that Clinton has 268 electors that are guaranteed to the democratic party. According to this model, 113 electors are still swinging and open for competition. Hillary needs at least two electors to win while trump must win all 113 electors.
Theoretically, Trump can reach this number. However, the majority of the polls predict Clinton to win. The website "538" estimates that Clinton will win 291 electors. The Huffington post was more decisive with an estimation of 98.1% that Hillary Clinton will win presidential race.
It must be noted, the race has tightened significantly in the past week, as several swing states that are considered must wins for Mr Trump shifted from favouring Mrs Clinton to toss-ups. According to Real Clear Politics polls, Clinton's advantage over Trump shrunk to 1.7%.
The economic manifest of both candidates plays a big part of this elections. While Clinton is the “status quo” candidate that will maintain financial market stably, it is Donald Trump who increases markets fear levels and is considered to be one of the most riskier presidential candidates in the American history. Last week, the VIX (Volatility Index) climbed 38% as concerns of 'Brexit Type' Response will repeat in the shape of Trump's win.
Hillary Clinton is still the favourite to win these elections, with a clearer path to winning of the Electoral College.
But Mr 'Brexit' Trump now has a plausible route to victory, especially if there is a sharp fall in turnout among African-Americans from the levels of the 2012 election.
Markets Reaction to US Elections
On Wall Street, the S&P 500 closed down for the ninth consecutive session — the first time that has happened since 1980.The recent moves reflect worries that investors aren’t sure whether to believe reassurances from polls. Last week, markets were volatile and risk sentiment was high. Both candidates want to increase spending and cut taxes which would be bullish for stocks and bearish for fixed income.
Analysts said a victory for Mr Trump, who has threatened to rip up existing US trade agreements, would hit the Mexican peso hardest amid fears that he could spark a global trade war.
Trades between Mexico and the US has grown to more than $500bn a year since the NAFTA (North American Free Trade Agreement) in 1994, making Mexico the US’s third-largest trading partner after China and Canada.
The US Dollar is expected to expand its gains versus other currencies in a scenario of Clinton's win as attention will be shifted to the federal reserve rate hike in December. A less optimistic vision for the US economy comes in case of Trump's win. The US dollar may weaken versus developed countries currencies as investors will seek safe havens currencies and commodities such as Euro, Yen and even the British Pound.
Precious metals will also suffer in case of Trump's win. Oil prices and Natural gas could get a lift as risk return to markets.
Markets tend to dislike the unknown - hence Donald Trump. When US election results will come out, it will be adapted into financial markets, and fast. The week ahead might be hectic with many opportunities.
sourceThe final countdown: Trading the US election - BAML
Narrower polls suggest markets aren't priced for tail risk outcomes
Bank of America Merrill Lynch on the US election:
The timing of poll closings on election night will be important for investors as markets adjust expectations in real-time. Exit polls will start rolling in from 7pm ET (perhaps a bit earlier), and will be staggered until around midnight .The outcome could be apparent much earlier in the evening with key battleground states like Florida, Ohio, North Carolina, Virginia, Georgia, and Pennsylvania all likely to release results by around 8pm. Conversely, a closer race implies a longer timeframe until the winner is known, and therefore, higher volatility on election night. Each of Trump's viable paths to the White House include winning Florida, Ohio, North Carolina, Georgia and Arizona.
As such, we think success or failure in these states early in the evening could give a good sense of the eventual outcome. We explore two possible scenarios:
Trump wins FL, OH, NC, GA; Buy JPY, CHF, sell CAD.
Trump success in each of these states early on would likely be negative for risk and weigh on the USD against the JPY, CHF, and EUR as the market would need to materially re-price his chances of winning. CAD and AUD would underperform as they are not materially pricing a risk premia for a Trump win, in our view. The hit to risk sentiment and increased volatility could last for a few hours until we get the results of other key states like Michigan, Colorado, Arizona, Wisconsin, Nevada and New Mexico after 9-10pm. Trump needs to win at least AZ, NV, and NM to have a shot at winning the Electoral College vote.
Trump loses FL, NC, OH, or GA; Buy USD (except versus MXN and CAD)
If Trump were to lose FL, NC, OH, or GA, his chances of victory could fall towards zero unless states which are now firmly Democratic in the polls (like Pennsylvania) vote Republican. As such, we will know the outcome relatively early in the evening even before the many other states are called. In this scenario, we would recommend buying USD (except versus CAD and MXN) as volatility falls and the market prices out the risk premia for a Trump victory.
Credit Agricole on Election 2016:
Growing political uncertainty ahead of the US presidential election has already been weighing on USD across the board, consistent with FX price action ahead of US presidential elections spanning the last 40 years. Despite Clinton's lead slipping in the polls of late,we think that the Democratic candidate will have a sufficient number of electoral votes to secure a victory, however.
The outcome will be supportive for USD and risk sentiment, and negative for the safe haven EUR and JPY if only because the uncertainty associated with a Trump presidency abates. FX volatility could subside as a result as well. We feel fairly comfortable in calling for renewed upside in AUD/JPY from here.
While not our central scenario, a Trump victory represents a nonnegligible tail risk and a reason for investors to remain very cautious at the start of the next week. We suspect that a surprise win of the Republican candidate will bring to the fore fears about rampant US protectionism and economic uncertainty, at least initially. This should weigh on risk and USD and support EUR and JPY as well as FX vols.
A smorgasbord of data releases and a central bank meeting are on offer next week. We suspect, however, that investors will focus on the releases only once the outcome of the US election is known and presumably only if Clinton is the new US president. We expect the RBNZ to cut rates but doubt that it will flag the beginning of a new easing cycle. A 'one and done' cut may not be enough to keep NZD down if risk appetite recovers in the wake of the US election, however.
Domestic activity data out of the Eurozone and Japan may play only a secondary role, especially if investors' demand for USD returns in the wake of the US election. Evidence that the Chinese FX reserves have dropped more than expected in October could rekindle bets on growing demand for USD-funding, and weigh on EUR and JPY against USD once again. GBP's bounce on the back of abating 'hard Brexit' fears could be put to the test ahead of the industrial production data next week.
We believe that the latest build-up in US crude inventories is only the beginning of a more sustained correction, consistent with a wellestablished seasonal pattern. Oil prices could thus extend their losses, and continue to hurt CAD and NOK. The latter could also struggle if Norwegian inflation were to surprise on the downside again next week.
In brief, Goldman Sachs say the likelihood of a meaningful Dollar rise in a Clinton win scenario is rising
The Dollar has fallen sharply over the past week, as polls have tightened into the upcoming election. On a trade-weighted basis versus the majors, the greenback is down more than one percent, a number that understates the decline because the fall in oil prices has weighed on the Canadian Dollar, which has a large weight in our Dollar index.
We show that recent Dollar weakness is associated with a meaningful pullback in market pricing for the Fed, with cumulative hikes through end-2017 falling to 32 bps as of Friday, down from 41 bps a week earlier. That said, the drop in the Dollar has gone beyond what rate differentials indicate, suggesting that a risk premium has formed even beyond expectations for Fed hikes.
The Impact of the US Presidential Election on FX Markets
Currencies are expected to be subject to considerable movement after the US presidential election on Tuesday night and Wednesday morning, especially if Donald Trump wins.
If investors have been reassured by the low probabilities quoted for Donald Trump winning the presidency - which peaked at 35% last week after email-gate and have since fallen to circa 17% following its closure - they should take heed of the recent referendum in the UK, which highlighted how sometimes even the unthinkable can happen.
With the UK referendum on membership of the EU, there was a quiet complacency that the safe and sensible option would prevail, and up until the last week that was backed up by a relatively safe lead for Remain in polls, however, on the day, a silent majority emerged to vote for camp Leave.
There is a case here to argue that the Trump and Leave vote are similar: both are predominantly white, blue-collar, not privileged, protectionist, non-tertiary educated, right of centre and deeply patriotic.
As such it also seems possible a ‘shy’ hidden vote could come out in favour of Trump on the day.
After all, who would admit to voting Trump in a telephone or face-to-face poll?
Just as many closet ‘Leavers’ were afraid they would be branded ‘racist’ for voting Leave, the same may also be possible for a secret mass of Trump supporters who likewise may be afraid of the stigma of voting for the candidate they actually deep down prefer.
So, it is with some caution that we interpret the low probabilities of a Trump victory as there is a possibility of a shy majority upsetting the expected result.
And it is with a Trump win, even more than the currently assumed Clinton win, that the most impact will be felt by financial markets, especially foreign exchange.
For, as noted by J P Morgan’s John Normand, in a recent preview of the election,” Of the macro asset classes, currencies should react the most to a Trump victory since his protectionist trade measures (tariffs on Chinese and Mexican imports) are easiest to implement via executive order than a fiscal programme requiring Congressional approval.”
The report goes on to specify the Mexican Peso and Canadian Dollars as being the biggest losers from a Trump ascendancy as they would stand to have the most to lose from the introduction of trade tariffs.
Despite some risk premia already being priced in, Normand says:
“We still think that the reality of a Trump victory could deliver at least 5% additional declines in CAD and 8% in MXN on Day 1 as markets overshoot due to an unprecedented environment of NAFTA disruption (both countries), restriction on worker remittances (Mexico), or extreme rate cuts (maybe two in Canada).”
J P Morgan’s Normand is keen to point out, however, that losses would be relatively short-lived.
“After Day 1, MXN’s depreciation could retrace quickly given that Banxico would probably hike 100bp and conduct FX intervention.
"CAD would retrace too but more modestly over the subsequent week and month since the currency is already cheap and because Congress could restrain Trump’s most protectionist tendencies.”
He sees the euro as appreciating in the case of a Trump victory due to the single currency’s tendency to benefit when “Washington creates an inhospitable investment climate.”
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Trading The US Elections: Targets For Equities, Rates, FX, Commodities
We provide a brief cheat sheet for the timeline and key issues to watch on election night, as well as our views on expected market reactions. Current polling would suggest a Clinton victory, the Republicans maintaining control of the House and the Senate returning to the Democrats by a slim margin.
Bottom Line: If current state-level polling is correct, Clinton would win 294 electoral votes, above the 270 needed to win.
Safe votes: Polling suggests 222 safe electoral votes for Clinton and 155 for Trump.
Likely Votes: There are then another 42 electoral votes from states (PA, WI, RI, ME, NH) that seem likely to vote for Clinton given her margin in the polls. For Trump, there are 25 electoral votes (GA, UT, AK) that are likely to vote in his favor unless there is a strong Clinton victory panning out through the night.
Leaning Votes: Given the tightening in the polls, the night will likely come down to the seven states that are leaning slightly in favor of each candidate. The above leaves Clinton at 264 votes, with 270 needed to win. Clinton would need to win one of the three states which are leaning marginally in her favor in the polls—North Carolina, Colorado, and Nevada. For Trump, there are four key races to watch to gauge his chances—Ohio, Florida, Arizona, and Iowa—here polls are leaning in his favor, but could be close. If he loses any of those, the odds of winning the Presidency are low.
Market Reaction:
In a Clinton victory, we would see Fed funds repricing December odds to around 85%, 10yr UST yields up 8bp and the curve bear flattening, underperforming other G10 rates markets, the USD mildly stronger with USDMXN 3% lower and USDCAD 1.2% lower, and a small rally in oil and base metals.
In a Trump victory, we see December 2016 FOMC odds re-pricing to 20%, 10yr UST yields don 12bp in a bull steepening, the USD weaker with USDMXN 6% higher and USDCAD and EURUSD about 2% higher, while oil and base metals fall around 4%.
Trading The US Elections: Scenarios & USD Reactions
We center on three scenarios:
(1) Base case: Clinton wins the Presidency, but with split government as the GOP keeps the House. The Senate can go either way, though we expect Democrats to narrowly take the Senate under a Clinton victory.
(2) Clinton Sweep: Clinton wins the Presidency and a strong performance down the ballot gives Senate and House Democratic majority. A narrowing at the Presidential race has reduced this already low-probability scenario.
(3) Trump Win: Trump wins the Presidency and a strong showing for Republicans leads them to keep their majority in the Senate. The Republicans also keep the House, as expected.
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The US election will continue to dominate markets in the coming week; narrower polls suggest markets aren’t priced for tail risk outcomes.
The timing of poll closings on election night will be important for investors as markets adjust expectations in real-time. Exit polls will start rolling in from 7pm ET (perhaps a bit earlier), and will be staggered until around midnight .The outcome could be apparent much earlier in the evening with key battleground states like Florida, Ohio, North Carolina, Virginia, Georgia, and Pennsylvania all likely to release results by around 8pm. Conversely, a closer race implies a longer timeframe until the winner is known, and therefore, higher volatility on election night. Each of Trump’s viable paths to the White House include winning Florida, Ohio, North Carolina, Georgia and Arizona.
As such, we think success or failure in these states early in the evening could give a good sense of the eventual outcome. We explore two possible scenarios:
Trump wins FL, OH, NC, GA; Buy JPY, CHF, sell CAD.
Trump success in each of these states early on would likely be negative for risk and weigh on the USD against the JPY, CHF, and EUR as the market would need to materially re-price his chances of winning. CAD and AUD would underperform as they are not materially pricing a risk premia for a Trump win, in our view. The hit to risk sentiment and increased volatility could last for a few hours until we get the results of other key states like Michigan, Colorado, Arizona, Wisconsin, Nevada and New Mexico after 9-10pm. Trump needs to win at least AZ, NV, and NM to have a shot at winning the Electoral College vote.
Trump loses FL, NC, OH, or GA; Buy USD (except versus MXN and CAD)
If Trump were to lose FL, NC, OH, or GA, his chances of victory could fall towards zero unless states which are now firmly Democratic in the polls (like Pennsylvania) vote Republican. As such, we will know the outcome relatively early in the evening even before the many other states are called. In this scenario, we would recommend buying USD (except versus CAD and MXN) as volatility falls and the market prices out the risk premia for a Trump victory.
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