USD and the US Election: Here’s What to Expect - UPDATE
USD has made some impressive gains this week, rallying from below the 93.00 mark to briefly above the 94.00 mark yesterday at one point. Driving the gains last weak was a combination of risk off flows that saw global equities and crude oil markets plummet (the MSCI world equity index is down nearly 4% on the week, whilst WTI crude is down nearly 10%) and US bonds rally, amid a demand for havens that also benefitted USD (and JPY).
Driving this week’s risk off tone has been focus on the worsening state of the Covid-19 outbreak, particularly in Europe, where a number of key economies (including France and Germany) have gone into partial lockdown in an attempt to slow the spread of the virus. This has contributed to further downgrades to European economic growth expectations for Q4 2020 and Q1 2021 relative to US growth expectations, driving weakness in European FX/USD crosses such as EURUSD (and further propelling DXY to the upside, given EURUSD makes up around 50% of the weighting of the index).
Surprisingly little focus has been paid to next week’s US Presidential election. That is set to change next week.
As things stand…
Biden has broadly held onto his commanding lead in national polling over incumbent President Trump in recent days. Real Clear Politic’s average of national polls puts the Democrat Presidential Nominee 7.4% ahead, a significantly wider lead that Hillary Clinton held over Trump at this point in the 2016 election (her lead was closer to 3%).
However, support for Trump continues to see upwards momentum; in national polling he is up from 41.2% on October 13th to 43.7% yesterday. In other words, undecided voters are breaking for Trump.
However, things have tightened in a few key battle ground swing states this week; Texas for example is now polling slightly in favour of Trump.
According to the FT’s election calculator, Biden looks likely to win at least 272 electoral college votes (more than the 270 needed to win). Trump looks likely onto the win 125. There are 140 electoral college votes from states considered a toss up (including Texas). Even if Trump wins all of these states, that will not be enough to swing the election. He needs to steal some of the states leaning Democrat, such as New Hampshire, Pennsylvania, Wisconsin and Minnesota. These states are polling strongly in favour of Trump at the moment, so it is hard to see how he could pull this off.
But note that polling likely underestimates Republican support; recent research has said that Republican voters are more than twice as likely as Democrats to lie about their voting intentions, with fear of having their voting intentions revealed to their families, friends or communities and subsequent reprisals (it is widely agreed that Conservatives are discriminated against in Democrat communities).
How market will react to all of this…
This is where things get juicy, or maybe I should say messy. Let’s go through a few scenarios;
Clear Biden victory on the night and Democrats also win back the Senate, Trump does not contest – A so called “blue sweep” is the markets baseline assumption. If Biden’s victory is then not contested by Trump, this ought to produce a strongly risk on reaction in markets, which ought to be a big USD negative.
Biden looks to have won on the night, but Trump refuses to concede election, contests result – This messy outcome would likely result in an eventual Biden victory, but there may be riots and civil unrest in the mean time and safe haven assets would likely be supported, with a preference for JPY over USD in FX markets, though USD should also do quite well.
Markets unsure of the immediate outcome of the election – Given the pandemic, mail in votes are at historic highs (probably around 80 million). Depending on the state, not all of these will be counted on election night, and counting could last a few days. Some have noted that voters on the night are more likely to vote for Trump, whilst mail in voters are more likely to be Democrats. A messy outcome, such as Trump trying to claim victory before all the mail in votes have been counted could occur, which the Democrats would likely contest. Again, the risk of civil unrest is high. As with the above, JPY would perform best, but USD would also likely do well amid risk off flows.
Trump wins looks to have won, Biden contests – As soon as it starts to look likely that Trump might have won, USD ought receive a strong boost, given Trump’s more aggressively protectionist policies. Given the election outcome would still be unclear in this scenario, there would still be risk off flows, but with Trump not the favourite for the Presidency, USD would likely outperform JPY.
Trump wins, Biden does not contest the election – Though there would likely be some risk off moves to begin with as this would strongly break against market expectations, we would have political clarity, which ought to eventually lead to stocks being supported. It goes without saying a clean Trump victory would be strongly USD positive. Stimulus expectations would likely have to be revised lower; once the Democrats know they have lost, they will likely compromise with Senate Republicans to pass a much smaller stimulus package.
The USD has been slammed during trading on today. Why? No fundamental reasoning behind this; it very much appears to be some technical positioning heading into the U.S. elections. The moves could even potentially be the market's way of making some room for chunky falls to come, PUMP and DUMP as the saying goes for the riskier currencies and assets.
Biden is seen as a positive for riskier currencies/assets - stocks, negative for USD.
Trump is seen as a negative for riskier currencies/assets - stocks, positive for USD.
If Biden wins, it could see an initial pop higher for riskier currencies/assets but would then sell-off if Trump says he will contest and USD would rally.
Safe-haven flows could also be observed if there is a split government.
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