Politics and Fed risks Trumpin the markets

The polls are narrowing ahead of next week’s US Presidential election. After holding a comfortable 7-point advantage versus Donald Trump last week, the latest polls suggest that Hillary Clinton’s lead has narrowed to just 2 points. Her projected number of electoral college votes has also shrunk to 246, earlier this week she was expected to gain 263, a mere 7 votes short of the 270 that she needs to be declared the winner of the contest. In contrast Donald Trump has seen his fortunes rise, and he is now expected to gain 164 electoral college votes, last week it was less than 130.

Although Trump still needs a big push to get to 270 electoral college votes, ever since email-gate raised its head at the end of last week, momentum seems to have shifted away from Clinton and towards the Trump campaign. The markets have reacted with a mini-Trump tantrum on Wednesday, as investors are given a glimpse of what a Trump win next week could mean for the markets.

Clinton could still clinch the win, according to the markets

However, the markets are not in full on panic mode right now, suggesting that they still think Clinton could clinch a win next week. This is reflected in the Vix volatility index, which is considered a fear gauge for Wall Street. Even though it has risen in recent days it is still below 20%, to put this in context, after the Brexit vote in June volatility spiked above 25%.

Global stock markets are generally lower on Wednesday, but US markets have outperformed their European counterparts even with 6 days to go before the US election. Interestingly, the Dow Jones Transport Index, considered a lead indicator for Wall Street, is higher today. Considering a Trump presidency is considered the worst outcome for the US economy, the fact that this index has not fallen further on the back of the bad poll news for the Clinton camp, suggests that the US equity market may not sell off sharply until volatility spikes further, or until the actual result is confirmed.

Markets are poll sceptics

The markets may be experiencing a healthy scepticism of election polls today, after all, if the market truly believed that Trump, a novice politician, was going to win next week then one would surely expect a large rush to safe havens such as US Treasuries and gold. However, the 10-year Treasury yield is back above 1.8% at the time of writing, after dropping to a low of just 1.78% earlier on Wednesday, this doesn’t suggest panic-mode to us.

The FX market is still on tenter hooks, USDJPY is at the lowest level since early October, while the Mexican peso is also down 1% today. USDJPY and the peso are likely to remain in the firing line ahead of the US election next week. The US dollar may continue to struggle, especially against the euro and the pound, which have embarked on decent recoveries at the start of this week.

Could the Federal Reserve shock the markets today?

The other thing to remember is the Federal Reserve. It will announce its latest policy decision later today. The market is expecting a 14% chance of a hike tonight. If the Fed does hike, that would throw the cat among the pigeons, and we could see a steeper sell off in equities, a rally in bond yields and a broad-based recovery in the dollar. However, in our view the bigger risk from today’s meeting could be a dovish slant from the Federal Reserve, who may not want to commit to a rate hike until the election result is confirmed. Although the Fed is expected to be politically neutral, a potential market sell-off on the back of a win for Trump next week could put the prospect of a December rate hike to bed for the Fed. Added to this, the Fed chair and vice chair have given speeches with fairly dovish slants in recent weeks, so a sell-off in the dollar on Wednesday could be in advance of a dovish “shock” from the Fed later on today.

Wrap Up

Overall, there is a lot of uncertainty for markets right now, and they are starting to show signs of vulnerability ahead of next week’s US election. Although the narrowing of Hillary Clinton’s lead in the polls has caused some nervousness, it has not triggered a sharp sell-off in risk assets, suggesting that investors have a healthy scepticism of election polls. Added to this, there could be some repositioning ahead of tonight’s Fed meeting, which may not deliver the clear signal that a rate hike next month is in the bag, and this could weigh on the dollar and push bond yields lower in the coming hours. Keep your hard hats at the ready!