How to Trade the US Elections – 08/11/2016 – by Arjun Lakhanpal

U.S. elections don’t typically cause major market volatility but the problem in 2016 is that for better part of this year, market observers did not contemplate a Trump victory credible and now that the election is too close to call they are bailing out of U.S. assets and rushing to shield their portfolios. Irrespective of your political leanings it is difficult to disregard the fact that investors dread a Trump Presidency. His foreign policy, trade ideas and plan to overhaul the Federal Reserve scares domestic and foreign investors alike and the general lack of specificity could mean a long period of uncertainty. Beyond the immediate impact, investors also worry that if markets sell-off and the U.S. economy slows the Fed could forgo a rate hike in December which would intensify the slide in the dollar into year end.

Based on how markets have responded so far to developments with regards to this race and particularly the first presidential debate, we believe that a Trump win could lead to an environment of risk aversion, mainly due to the heightened doubt surrounding his policies. Thus, safe havens such as JPY, CHF and gold may rally, while riskier asset like stocks could tumble. On the other hand, a Clinton win may signal the continuation of the current political status quo, given that her policies are more or less similar to Obama’s thus her victory could largely have the opposite effects across asset classes. Let’s consider the 3 potential outcomes of Tuesday’s election:

Scenario #1 –Trump becomes President, Clinton accepts defeat

The greatest market impact would be a Trump victory and a willing Clinton defeat. In this scenario, the U.S. will have a man with untested political skills and unknown policies in office. In this case, the biggest winners will be the Euro, Swiss Franc and Japanese Yen and the biggest losers will be the U.S. dollar and Mexican Peso. The Canadian dollar should also fall but its moves could be tempered by a weakening U.S. dollar.

Scenario #2 –Clinton becomes President, Trump accepts defeat

The greatest relief for foreign investors would be if Clinton becomes President and Trump willingly accepts defeat. She’s not without her own problems (and there are many of them) but the transparency of her policies and the continuity of stability would send the U.S. dollar sharply higher. In this scenario, the dollar and peso would rise against all of the major currencies with the biggest losers being the Japanese Yen, Swiss Franc and to some degree the Euro. However she would need to win by an uncontestably wide margin and Trump would need to accept defeat, which he has suggested that he wouldn’t.

Scenario #3 –Trump/Clinton becomes President by narrow margin. Loser refuses to accept defeat

The third scenario is the most likely one. If Trump or Clinton becomes President by a very narrow margin and the loser refuses to accept defeat, the ongoing uncertainty would be extremely negative for the U.S. dollar, especially in the hours after the election. However, on a percentage basis, the greatest market volatility in financial assets (currencies, equities and commodities) will be in scenario 1 and 2.

Despite this, it’s still too close for market to get comfortable. It’s clear that Trump is the candidate that would place create more instability for the US economy and markets, just from the fact that his intended policies are more radical and more far reaching that Clinton’s.