The Election's Implications For FX Markets
Over the last few weeks we have looked at where the two candidates stand, the implications of a Romney win on the economy, how investors are positioning in equity and bond portfolios for each candidate's potential victory, what gold will do, what stocks will do, and the fact that either way; the easy-money days are over. The last market to look at is the largest - the foreign exchange market - and Citi's Steve Englander provides a succinct explanation of how the various asset-class shifts post-election will impact flows in the FX market. Most specifically, how sensitive various safe-haven and risk-sensitive FX crosses will be to House composition. He also notes the potential for knee-jerk reactions as timing issues across various state poll closings offers exit poll information - especially as a Romney win is very much not priced in.
Market implications of election outcomes
Today’s sell-off is not about the election. It is primarily driven by concerns on the Greek vote, Spanish collateral and to a lesser degree, concern that the ECB will cut rates this Thursday. In the US the polls have coalesced on an Obama victory, although there is still optimism on the Republican side based on the diminished Obama buzz in 2012 versus 2008, the size of Romney-Ryan clouds in swing states, and the opacity of the adjustment that pollsters make in gauging likely participation in the election (reminiscent of the BLS’ birth-death adjustment for payrolls, where the imputed number often dominates the actual count). So by now, you have to see an Obama win having modest impact on asset markets and a Romney win being the big surprise. So what to look for:
- If Obama wins, the initial reaction might still be some modest buying of fixed income, on the view that the Fed will be encouraged to proceed on its QE path and there will be more continuity at the end of Bernanke’s term. Equities may be a tug of war between the easier Fed view and the less-business-friendly/end-of-capital-gains-tax-reduction Obama view. On FX we could see some backing off from the short JPY trade, although that trade has more to do with Japan than the US over the medium term, and maybe some re-buying of CAD. Overall probably negative for the USD, although the immediate effect should not be large. In the first instance the main winner is CAD; JPY also in play given positioning and rate sensitivity. Other winners AUD, NZD, NOK as QE-continuity trades. SEK may lag given its equity link.
- After the initial Obama-win rally, the fiscal cliff comes into focus (this may take a few days to a few weeks). We would pay particular attention to the composition of the House. Going into the election, the Republicans have 240 seats vs 190 for the Democrats. The expectation at the beginning of the campaign was that the Democrats would pick up a couple of seats, but that Republicans would retain a significant majority. Were the Republicans to hold or improve their majority, they may be emboldened to take a harder line in fiscal cliff negotiations -- unambiguously positive for fixed income, negative for risk-correlated assets and paradoxically positive for the USD. However, the USD surge would reflect safe haven flows in Treasuries, rather than any expectation that US assets would outperform on a cyclical or structural basis. JPY the big winner on downward US rate move. CAD, AUD, SEK, NOK and other risk correlated currencies are most vulnerable on the downside.
- If the election is uncertain – which is possible if voting is very close in key states – it would probably be viewed as raising the odds of a Romney win, or at least raising uncertainty. On that basis, we would lean to initial concern that we would see austerity both on the fiscal and monetary side – commendable from an ideological viewpoint, but unlikely to inspire confidence in asset markets. So we would lean to partial risk-off. Note that results may be clear, even if they are not final so the informal period of uncertainty may be less than the formal period. Romney partial or full win – immediate reaction is fixed income sell-off and equity sell-off so JPY is vulnerable as its main correlation is via rate differentials and CAD is particularly vulnerable on fears of US fiscal tightening and economic slowdown. Other risk-correlated currencies sell-off as well.
- Romney win is really not priced in. In the first instance we think the reaction will be concern that he will tighten on the macro side prematurely and lead to a broad sell-off in equities and fixed income, and buying of USD, but we think he will quickly back-off from the Ultra-view of where policy is headed. So if Romney backs off from immediate macro tightening and fiscal cliff is put off, equities could come back, as well as risk-appetite in coming weeks.
Exit polls will be carried on all day long, with a consortium of media sources combining efforts. Most news sources have agreed to quarantine all details of exit polls till until polls close, but some details on the demographic composition of voters may be released at 5-6PM EST, so some investors may draw inferences from these data. Exit polls, especially partial ones have a mixed reputation, because the demographics of early AM voters differ from those of noon and PM voters.
- Virginia and Florida polls close at 7PM EST so those might be the first battleground states that report, and we may quickly know if there is a wave one way or another in these states.
- Ohio closes its polls at 7:30PM EST and will quickly publish absentee ballots. If those ballots show a big swing from 2008, it may signal increased Romney odds. Ohio will then publish results from big counties every 15 minutes, so if the result is clear, we should know by about 9-930pm who has won Ohio. If it is Florida-2000 close, the count could drag out for weeks.
- Other states that close at 7:30PM – North Carolina and West Virginia.
- Pennsylvania and Michigan polls close at 8PM, so if there is an upset, we will likely know it from other states first.
Link to poll closing times --