FX update: US Election scenarios

The election and reaction functions:

Note: In case you missed it, we hosted a webinar How to trade the US election with some thoughts on market reaction functions to different scenarios across asset classes. In

JPY should be the most sensitive major currency to US election outcomes versus the US dollar, with the focus on how the election impacts US yields. Due to this week’s reaction to the UK budget statement and jump in yields there, however, sterling may also prove surprisingly reactive in the event long US yields surge in either direction (sterling theoretically moving in negative correlation with US yields). In theory, the CNH should be very sensitive as well, but with the heavy hand of officialdom weighing there, its ability to move is questionable. In EM, the focus is on MXN on the threat or lack thereof from Trump tariffs should Trump be elected. Let’s also realize that implied volatilities ahead of the event are very high – this could mean that moves against the “most feared” direction (USD upside, MXN and JPY downside) could be very sharp as well as expectations are leaning for a Republican sweep, or at least, that is considered the most volatile scenario and the one that traders see the need to hedge for.

Regarding the timing of the result – it is impossible to tell. The market will try to suss it out as early as the hour after the polls close in Florida and other states (midnight GMT), but the tallying patterns will be different this time around. If the election is so close that we have to wait for the final results of a single state – Pennsylvania seen as the most likely single state prize that makes the difference – we could have to wait a day or even days.

Outcomes and reaction functions

Republican sweep or “Trump 2.0” – This is the most difficult scenario to gauge the reaction function to because the potential policy impact would be the largest and because it is already priced in partially, or at least very pricey to hedge. But is it 50% priced in or more/less? US treasury yields and in particular the 10-year yield is the prime mover among the different markets to watch. The “next step” question after any initial knee-jerk reaction is whether the market still thinks a Trump administration could get away with further tax cuts that would aggravate the yawning deficit even more (i.e., would stocks surge on tax cut/deregulation anticipation or fret the bond market volatility – something that may finally be wearing on market nerves in recent days, or was that specific earnings news flow….?). So, is it “risk on and yields up” like the 2016 playbook or “yields up and run for cover”? The latter would hit traditionally pro-cyclical currencies harder, arguably.

Guesstimate of market reactions: US long yields: jump toward 4.50%, approximately the descending trendline contact point. USD: Generally surges higher still across the board, especially in USDJPY by at least 200 pips or more. USDCNH left to its own devices might quickly challenge the top of the range, but official interest in managing the situation would likely be lurking. USDMXN could surge far more, perhaps 5% or more. The short-term implied volatility suggests extreme concern levels for USDMXN in the wake of the election.

Trump gridlock – as I have noted, if the election is as close as the polls say, the House could go to the Democrats by a narrow margin even with a Trump victory. This is a very different scenario from Trump 2.0 as it derails the risk-positive potential for tax cuts/deregulation, but you still have the volatility risk from Trump tariffs. USDMXN may be at almost equal risk to upside as in the Trump 2.0 scenario and the same goes for USDCNH, but the US treasury market could breathe a sigh of relief and yields could be more sideways. This is less bullish the US dollar than above, particularly for USDJPY if US treasury yields ease lower.

Harris gridlock – much like the status quo, just that the Senate presumably is won by the Republicans and Democrats take the House. The Senate control by Republicans potentially blocks presidential nominations. The market reaction here might be mostly about deflating the Trump 2.0 concerns/anticipation and then quickly moving on to obsess about where the US is in its economic cycle as well as Nvidia earnings and whether the stock market run can continue. It means the least volatility for markets in the longer term relative to all other outcomes, so any initial negative reaction might fizzle quickly. With no Trump tariffs, USDMXN could see the most profound moves lower among USD pairs, USDCNH also likely to get some relief and USDJPY to head sharply lower (most ideal scenario for JPY as this is the most benign scenario for US deficits, presumably allows US yields to drop back sharply).

Democratic sweep – this would be a true shocker for markets, as the Senate looks extremely unlikely to go to the Democrats and would mean that the polling was quite off nationally and in at least two Senate races. This would likely be immediate risk-off and USD sharply lower on anticipation of corporate tax hikes that will be a punch to US company valuations. We would likely also see a huge relief trade for USDCNH and USDMXN and slightly less so for USDJPY as Trump tariffs are avoided entirely. The treasury market bears watching in this scenario – would it also fret expanded deficits under a Harris administration and keep yields and Fed expectations relatively elevated? One wild card here: could we have neither party with a majority in Congress, as the last seat that makes the difference is the avowed non-partisan Osborn running in Nebraska, making him the king-maker swing vote?

Also on the calendar next week (times are GMT where shown):

RBA meeting, Tuesday (0330). AUD more likely reactive to CNH and US election outcome scenarios, as well as China stimulus announcements than anything the RBA is likely to stay. Market believing RBA’s guidance for no urgency to cut rates, not pricing in the first full 25 basis point cut until May of next year.

US Oct. ISM Services, Tuesday (1500). The September survey was confusing, with a big pick-up in the survey, but weakness in Employment. A bit more focused on the latter for this report as an input to the FOMC decision and guidance.

US 10-year treasury auction, Tuesday (1800). What a day to have this, on Election Day!

Riksbank Meeting, Thursday (0830) after Sweden October CPI (0700). SEK has paid for the Riksbank dovishness of late, as well as Europe’s malaise and perhaps the overall risks to global trade from Trump 2.0 trades that have been put on in recent weeks. They’re expected to chop another 50 basis points to take the rate to 2.75% - could there be an easing up on the dovish guidance, though,  if EURSEK is toward the top of the range?

Norway Norges Bank meeting, Thursday (0900) Norges Bank doesn’t appreciate the krone weakness, not that it has helped NOK any. Yesterday, the bank announced it will drop daily purchase of foreign currency to NOK 150M next month vs. NOK 400M now – a NOK-positive development at the margin.

UK Bank of England meeting, Thursday (1200). A difficult meeting for the bank after the autumn budget blasted gilt yields higher on the fears of stagflation from the heavy borrowing and taxing programme the budget brings. If US yields are rising because of a Trump 2.0 or Democratic sweep, the pressure on UK gilts and sterling could double - while if US treasuries rally on a gridlock outcome and gilts ease well back away from the highs established last week, the BoE might get away with the expected small cut, but will need to be cautious on guidance for further easing.

FOMC meeting, Thursday (1900). The market strongly believes that the Fed will have to cut another 25 basis points at the meeting, but the expectations beyond have softened up considerably beyond that, with less than 100 bps of easing priced through next May even after today’s weak jobs report. US election outcome, if known, will have to shape their expectations, if only between the lines (Harris gridlock offers the clearest path for continuing to steadily cut.).

Canada jobs data, Friday (1330) Canada’s rising jobless rate has kept the BoC on a more aggressive rate cutting path – an interesting data point here as USDCAD has risen to the top of a very long term range – 1.4000 is a major level.

US Nov. Flash University of Michigan confidence, Friday (1500) The huge jump in the Conference Board confidence indicator in October suggests political fervor at work and this could affect this survey as well for this month and more before things settle next year.

Table: FX Board of G10 and CNH trend evolution and strength.

Note: the FX Board trend indicators are only on a relative scale and are volatility adjusted. Readings below an absolute value of 2 are fairly weak, while a reading above 4 is quite strong and above 6 very strong.

Everything might change next week, but worth a look at the status quo ahead of a critical week ahead.

Table: FX Board Trend Scoreboard for individual pairs.

Note the ice cold volatility readings for the US dollar pairs – surely that changes next week?