US election: the playbook

We head into the eye of the storm with the market craving certainty around the US presidential election on Wednesday, and I’m just not sure the market will get all the information it wants.

Source: Bloomberg

Despite Trump closing the gap of late, the market’s base case scenario is that we’ll see a Clinton presidency with a Democrat Senate and Republican House, followed somewhat behind by a Clinton presidency and the Republicans gaining both the Senate and the House. The wind is to Trump’s back in the polls, though, and the prospect of a Trump win and a split congress has increased.

Markets have been responding with traders reducing risk, buying volatility structures (the volatility index or ‘VIX’ has gained 73% in the last seven sessions) and increasing exposure to safe haven assets such as gold or JPY to ride out this period of uncertainty. However, I feel the market is specifically keen to understand:

  • If Trump does win, will he genuinely follow through with his promise to sack Janet Yellen? How much influence would Trump exert on the Federal Reserve?
  • Will the loser even accept the result, or will we be thrown into a period of uncertainty similar to 2000 and the Bush vs Gore election?

Key times to consider on Wednesday

Similar to the UK referendum, the vote counts will be staggered through the day and a candidate must gain 270 votes through the Electoral College to be named president ( understand more). Each state therefore carries a different number of Electoral votes, but it’s the swing states that are most important in determining who will be named president. The states that will really get the market’s focus above others include Florida (polls close 11:00 AEDT), New Hampshire (11:00 AEDT), Ohio (11:30 AEDT), North Carolina (11:30 AEDT), Pennsylvania (12:00 AEDT), Nevada (14:00 AEDT) and Iowa (14:00 AEDT). Results of each state should be known within 1-2 hours after the times disclosed.

Keep an eye on Pennsylvania, North Carolina and Florida. If Clinton polls well here (say taking two out of three states), the market will feel the probability of Clinton polling well in other key battleground states is elevated.

In terms of absolute votes, the states with the largest number of votes are: California (55 Electoral votes), Florida (29 Electoral votes), New York (29 votes), Texas (38 votes). California will be latest to report their votes at 15:00 AEDT.

If the result is not close, we should have a firm understanding by 15:00 AEDT.


Why markets fear Trump

Trump has promised to sack Janet Yellen and has been hugely outspoken about the Fed’s loose policy setting. Impede the market’s support mechanism (ie. the Fed) and risk assets (such as equities) have to wear a higher risk premium. It seems logical that markets will remain skittish until they understand the relationship between Trump and Yellen, and the ramifications of higher tariffs on nations such as China, Mexico and Japan. When most countries’ growth is running below trend, we can understand the nervousness about Trump’s protectionist policies.

If it weren’t for Trump’s views on the Fed and trade tariffs, markets would actually prefer a Trump victory. His promise to lower corporate tax, married with a sizeable fiscal stimulus will promote huge foreign direct investment, and also improve the current account. This should boost the USD longer-term, as will his calls to offer a tax repatriation window, allowing companies to bring some of the trillions of USDs held offshore back to the US and not be taxed 35%. He has also expressed a move to lower regulation around his financials so US banks would benefit from a Trump win longer term.

I also look at Clinton’s policy on capital gains tax, where she has proposed a sliding scale, dependant on how long the individual has held the asset. If an asset has been held for six years or longer then they will pay just 20% and this suggests investors will be incentivised to hold assets for longer. However, we may see an initial sell-down as she is also suggesting individuals pay their marginal tax rate if they haven’t held the asset for two years. So we may actually see traders bringing forward and realising capital gains in this tax year. That could cause instability.

Trading the decision

The markets have told us they view a Trump win as a negative, so watch the various states and how the market reacts. Specifically, I would use these assets as the best guide:

  • US 500 cash – A Trump win could push the US market into the June lows of 2000. A Clinton win could see a relief rally, perhaps pushing into the September and October lows of 2116, although I wouldn’t be surprised to see sellers emerge. Understanding positioning is key, so remember there have been a lot of portfolio hedges that needs need to be unwound if Clinton gets in, again boosting the chance of a relief rally.
  • Spot gold – If Trump realistically looks like he’ll be getting the Oval Office, then I would expect traders to push gold into $1340. Gold would likely get a boost from weakening USD in this scenario.
  • The USD basket – A Trump win should push the USD lower as the market prices out the chance of a December rate hike. The market is currently placing a 78% chance of a hike, and I would expect this probability to fall closer to 40-50%. The best trade here is USD/JPY and one questions whether we’ll see the pair test the ¥100 level.
  • USD/MXN – One of the purest reads on sentiment. Mexico is one economy that stands to lose the most as a result of Trump abolishing NAFTA (North American Free Trade Agreement). A Clinton win should see a strong rally in the MXN, potentially testing the 18 level over a more medium-term basis.
  • Volatility index – A market to trade with care as it can have extreme moves. However, it will provide a good guide to whether the market is impressed by what they are seeing on the day.


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