As a very observant Charlie McElligott of RBC points out, lost in a sleepy Friday morning session, there was a sneaky trade in November Fed Funds Futs (FFX), where somebody bot 9962 Calls in what was essentially a ‘Trump Hedge’ lotto-ticket that pays in the event that the FOMC were to LOWER the Fed Funds rate…thus, quite notable.
More polling data out over the weekend shows Trump and HRC in a “dead heat” (per left-leaning WaPo), with Trump taking a lead on Clinton in the key state of Colorado, while closing his gap in Pennsylvania to just 1ppt as well.
Below we present the rest of Charlie's thought on what Trump's recent surge means for markets which, as we noted earlier, aside for the Mexican Peso, have largely failed to price in the "risk" of a Trump presidency.
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I am still amazed at how few clients are talking about tonight as a potential “accelerant” w.r.t. the recent “Trump strengthening trend.” The DC folks we speak with continue to see this much closer than some of the probability projections are currently showing. How can it be so close, despite HRC’s structural (funding & “professional and veteran” campaign managers) and demographic advantage? Because per some data sets, Trump is making up for this by being considered stronger head-to-head with Clinton on the perceived ‘top 3 issues’ for this electorate: the economy, terrorism and immigration.
My RBC Macro teammate Mahmood Noorani has recently input the publically available historical data on “Trump victory odds” into the Quant-Insight macro factor PCA model. The data shows that up to this point in time, Trump’s recently increasing odds have had little impact on equities or FX (as per ‘now,’ it’s not reflected as a “price driver” in either asset—seemingly ex-MXN). This goes back to my anecdotal point above: despite the polls reflecting better Trump odds, stocks are not pricing in much of anything, and are considering this still to be a “left tail” event. That said, the model is showing a larger current impact in US rates / Treasuries. Per Mahmood’s first blush, the “…longer you go out the curve, the bigger the effect. Trump victory = yields higher, curve steeper.” This likely reflects the expectation for massive fiscal policy expansion with his infrastructure plan. To a much lesser extent, the model also shows us that the recent “Trump effect” has been a “slight positive for the US Dollar” as well, and one I would assume in an outright Trump victory would only further strengthen from the ironic “flight to quality / liquidity” trade.
Per the experiences of this past month, the global cross-asset volatility spike was entirely driven by the long-end selloff in major sovereign bonds around the globe (as triggered post the BoJ / Sakurai commentary on steepening the yield curve). If a Trump victory were to indeed drive yields higher and the curve steeper, it would likely then too drive equity vol higher as well—as the crowded ‘duration trade’ could get slippery on the unwind, especially after the multi-day collapse in vols in both rates and equities (post Fed / BoJ) has enabled leveraged strategies to add-back sizeable length to the trades (risk parity effect) which would seemingly the be exposed.
Clearly there is a qualitative market expectation that a strong Trump showing will drive VIX higher / equities lower—but that’s all it is for now, as it’s certainly not quantitatively pricing much of anything in; tonight’s debate could “make or break this.”