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As the US election approaches, investors and traders have turned to financial markets to express their views on the outcome of the vote as Republican nominee Donald Trump and his Democrat opponent Hillary Clinton traverse swing states that may decide the election.
While the political action is being played out domestically in the US, markets are reacting globally. Bets have been placed as traders brace for an uptick in volatility. The Mexican peso, the world’s second-most traded emerging market currency, for example, has found its fate linked to the rise and fall of Mr Trump.
As Mr Trump skulked behind Mrs Clinton at a debate in October following the release of a video in which he brags about groping women, foreign exchange traders in Asia sprang into action. Before a poll could capture how his performance would sway voters, the Mexican peso rallied to a one-month high. Over the subsequent two days the number of short contracts on the currency — in which investors bet the currency will decline further — fell to the lowest level since the end of August.
Never mind that little changed on the economic front in Mexico where consumer confidence has been slipping, inflation has eclipsed expectations and industrial production has fallen short of projections.
“Politics continue to trump policy and this persists as the key theme of our current trading views,” says Kamal Sharma, a strategist with Bank of America Merrill Lynch. “Price action remains beholden to US presidential elections.”
The peso is not the only asset that has come under intense speculation. While many investors are positioned for sharp prices swings by sitting on the sidelines, others are turning to derivative markets in the hope of a pay-off.
Stock markets could be one of the more straightforward ways to try to make a portfolio election proof. Deutsche Bank equity strategists have even proposed a series of pair trades — in which an investor could go long one industry while shorting another — based on the projected outcome.
A Democratic clean sweep — winning the presidency and gaining a majority in both houses — could prove calamitous for healthcare and pharmaceutical companies, which have been the target of heated criticism from the Clinton camp over drug price rises. By contrast, Mr Trump in the White House would “be good for some domestic oil producers, as it should permit more drilling”, Deutsche notes.
As Mrs Clinton strengthened her lead in the first two weeks of October, healthcare stocks retreated, becoming one of the worst performing sectors within the benchmark S&P 500.
By mid October, the Iowa Electronic Markets, a political prediction market, put the odds of the Democrats taking both houses at roughly 20 per cent. That was more than twice as likely as the 8 per cent it quoted at the beginning of the month.
A clean sweep for the Democrats would “represent one of the toughest election outcomes for banks” and open the door to tougher regulatory scrutiny, say Morgan Stanley strategists.
Inflation expectations have been rekindled as the possibility of single party control swings into sight. Democrats and Republicans are both expected to shirk austere fiscal spending, touting large infrastructure projects that could be backed by either a surge of new municipal bond or Treasury offerings.
“The fiscal spigot could be wide open if the Democrats sweep the House, Senate and presidency,” says Wells Fargo strategist Mike Schumacher.
If Mr Trump wins and keeps to his pledge to implement large tax cuts, this could increase the US deficit by more than $5tn, the non-partisan Committee for a Responsible Federal Budget has estimated. It sees Mrs Clinton adding $200bn to the deficit. Either could prompt selling in longer-maturing Treasuries, propelling 10- and 30-year government bond yields higher as short-term rates remain bound by the Federal Reserve’s pace of hikes.
“On the margin it means higher inflation and steeper [yield] curves,” says Raman Srivastava, deputy chief investment officer of Standish Mellon Asset Management. “We are moving duration from the back end of the curve . . . and moving to higher quality paper that will remain liquid even amid volatility.”
While the euro, pound, yen and renminbi have been most affected by developments happening closer to home, other currencies’ fortunes are strongly tied to what happens in the US.
Barclays strategist Aroop Chatterjee notes that when Mr Trump has gained in polls, it has led to “a spike in volatility, demand for safe and liquid assets” and negatively affected riskier assets like emerging market currencies.
The Mexican peso, Korean won, Norwegian krone and New Zealand dollar would all pop higher in the aftermath of a Clinton victory, Barclays says. They would each slide if Mr Trump carried the vote.