Election Pulse: It’s not over yet

Both betting odds and markets are gyrating as the 2020 election results have begun to trickle in. The race is closer than the pollsters outlined (again) but it is still too early to call.

What we know:

1. Be careful with the states vote count. Election Day ballots vs. mail-ins, be sure on what is being counted before calling the result. Election day votes skew Republican and vice versa
2. Be patient, it is not over yet. Some states will be very close. This means all votes must be processed before pulling the trigger. In Pennsylvania ~2.2mn mail ballots are yet to be counted, that is about ~87% of the total. The race is closer than expected, that means it could all come down to Pennsylvania where local officials are reporting it could take until Friday for the result.
3. There are still paths to victory for each candidate, even a tie in the Electoral College is possible. Based on the Electoral College and Biden taking Arizona, Trump needs Pennsylvania. Betting odds have swung wildly, from Trump soaring to almost 80% and now dropping back below 60%.
4. The race is close, the risk the outcome is contested remains high.
5. The Senate race is tight and it seems at this stage the status quo may be maintained.
6. Turnout has been significant, but the race is close – Whatever happens the country remains heavily divided with huge fissures across values, preferences, priorities and the like. This is not the election to heal a nation divided.

AND…

1. Pollsters are out of the job

As it happened

The “blue wave” trade faded fast as the race tightened and it became clear Trump was pushing ahead in Florida. The USD and Treasuries were bid, the Yuan saw big swings and MXN got hit by surging Trump odds. E-minis were offered then sharply reversed and jerked higher.

Very quickly, NASDAQ futures ripped higher – a fading reflation narrative benefits the earnings duration growth stocks that comprise the index. In addition, the reduced risk of monopoly crackdown and tax increases under a blue wave scenario contributing to the gains.

Focus shifts to the battleground states

Betting odds have flipped again and traders are clueing onto the fact that the result will not be known today. With no big battleground state flipping relative to 2016, there are paths to victory still open for both candidates and it is too early to tell who has the race in the bag. This realisation is seeing risk sentiment fizzle off session highs. It could be days for the final result, volatility/choppy trade will remain without a definitive picture.

The states we may have to wait for:

• Pennsylvania
• Michigan
• Wisconsin
• Georgia

In Pennsylvania ~2.2mn mail ballots are yet to be counted, that is about ~87% of the total. The race is closer than expected, that means it could all come down to Pennsylvania where local officials are reporting it could take until Friday for the result.

That said there are few reasons to be more confident in the polling across Pennsylvania, Michigan, and Wisconsin. The betting odds favour a Trump win in all 3 states.

The Senate race

As I write, it looks like the status quo will be maintained in the upper chamber of Congress, blue wave odds have declined fast.

This means a stimulus deal will have to clear a Republican Senate, where the current majority in the Senate has been the hold up. It’s the Senate race that holds the most answers for risk assets as it will be crucial in determining the timing and size of another round of aid that the US economy so desperately needs with benefit cliffs fast approaching.

Georgia is going to a January runoff between Republican Sen. Kelly Loeffler and Democrat Raphael Warnock, so we won’t know the full composition of the Senate until January.

A Trump win and Republican Senate majority would keep the status quo, which hasn’t been bad for risk assets! A big spending package will support the US economy and markets, whoever is President and fresh of the win, Trump (no stranger to spending big) could bully Senate Republicans into reaching a deal on stimulus and push a package through congress before the end of the year. Failing that there is always a fall back of executive orders etc. Trump is no fiscal conservative and would likely weasel a way to push something through.

Gridlock – A Biden win and Republican senate is a big hit to the reflation trade. If Biden wins the presidential race but Republicans retain the Senate majority the WH will be hamstrung until at least the 2022 mid-term elections. Mitch McConnell and the GOP fiscal conservatives will be a huge obstacle for a big Biden spend, and it is very unlikely a sizable package would see the light. A skinny deal could perhaps be reached. A lack of fiscal support and little prospect of a big package even after Biden’s inauguration in January coupled with rising virus cases could become quite negative for risk assets. A silver lining would be unchanged tax policy and a more collaborative foreign policy stance with the possibility of tariffs on Chinese imports being wound back which would be supportive for investor sentiment. Moreover, if delays in approving fiscal relief for the COVID-hit US economy weigh on consumer and business sentiment this could see the Fed implementing an expanded QE package to support the recovery come December. The Fed will keep policy steady this week immediately post the election, but will be contemplating further policy easing, particularly if fiscal stimulus remains absent.

The contested risk

The race is closer than expected and without the Democratic landslide, the probability of a contested outcome remains.

The tighter race, leaves it down to key states like Pennsylvania where mail-in ballots have surged. Accusations of fraud surrounding the mail in ballots could see the outcome contested. Distrust in the legitimacy of the result has already been roused. That distrust, alongside the societal polarisation which has been supersized by the impacts of COVID-19, sees division ripe for exploit, in many ways primed for undermining public confidence in the electoral process.

These risks support the notion of choppy markets until the presidential election and any ensuing legal challenges are out of the way and result is known.

In the contested election in 2000, the S&P 500 dropped ~9% before George W Bush emerged as the victor in early December, when the Supreme Court ordered a stop to the Florida recount following a month long legal dispute. This year’s election could come with an even greater legal challenge should the results be a close call. 

Large hedges in the form of put options are in play through to December 2020 and if dealers looking to hedge, short futures on any post-election jitters, this could be a catalyst for more broad based weakness. As we have seen before, most recently in August 2020, dealer hedging has the capacity to exacerbate directional market moves.

Bottom line - be prepared. Nothing is certain yet.