With US presidential elections just 3 days away, Monday 7th November will be the last full day for big players to be able to reposition themselves.
The intent of this article is to offer a concrete scenario about what will happen during the period when election results will start to become known.
Before we start, important parallel for what the market might do is the Brexit vote. Spreads during Brexit were not extremely high, because the results of the vote came in gradually. In other words, market had more than a minute to adjust to new scenarios. True, the moves in GBP were big, but they took more than an hour to develop before Brexit vote transitioned from possibility to certainty.
It is interesting to observe how our sensitivities have changed after 2008. Now the black swan events are supposed to be 1 minute events, like the most recent GBP flash crash. We don’t expect any black swan event on election night in terms of ultra wide market spreads.
Nevertheless, we do expect a lot of market movement. Yet, liquidity during the event will be most probably decent because so many investors and traders will be watching the event and will also take positions in the market the whole time when results will gradually be released.
None of the candidates is proposing a status quo. At least not nominally from what they publicly communicate to the voters. The candidates have oposing views and both possible outcomes can influence the market greatly. This fact alone is relevant for managers and traders, who want to quickly react and reposition their portfolios in the wake and right after election results will become known.
In this sense the particular market in mind is foreign exchange market and the US Dollar.
Hillary Clinton is proposing a tax increase. Her policy is of socialism-like liberal approach with a lot of additional burden for the general public and a lot of social welfare moving through specific channels like an open border policy, funding of sanctuary cities and increasing the minimum wage for example. With her the US is moving further away from capitalism.
Her statements indicate she would not want to increase debt and is looking to balance out any additional spending, like discussed during the presidential debate. Her plan is economically not very radical in terms of immediate central bank balance sheet expansion or immediate budged imbalances.
SPLITTING HAIR POLICY
That is not to say these effects would not develop down the road as a result of her policies, since growth prospects from her proposals are not very promising. It is a splitting hair policy, where costs can build, but growth cannot get unlocked. Like in socialism, a lot of groups are entitled to support, but there is no link between net new value created and payouts. It is an entitlement driven vision, which boosts the power of the state.
Nevertheless, important thing for the next week is early effects on supply and demand of capital the market will want to price in immediately once the winner of the election will be known.
FAST ROLLER COASTER
Donald Trump on the other hand in many ways has a diametric view to his opponent. Rebuilding bridges, highways, tunnels, airports, hospitals, schools, the depleted military, bringing education local, replacing Obamacare, strengthening the US border, all while taking care of veterans and providing stronger support to law and order officials along with the most aggressive tax cut proposal is all at once a very toll order financially.
REPATRIATION OF PROFITS
Trump’s idea is to neutralize this very fiscally aggressive approach by luring in a lot of US corporations’ money, currently parked overseas. He is stating that repatriation flows under his 10% repatriation rate plan would amount to $2,5trn. If corporations would like the opportunity for less expensive movement of their capital, that could happen.
When former president G. W. Bush tapped into this territory the repatriation flows amounted officially to $362bn, but according to anecdotal information to over $600bn in 2004. Without a doubt this strongly supported the US Dollar at the time as more experienced market participants remember. US currency rallied by more than 15% against the EUR when George W. Bush tax break went into effect.
PAYOUTS INSTEAD OF NEW JOBS
However, it is beyond the scope of this article to fully examine long term effects this policy could have on the economy. WSJ writes in an article, US Congress did not find the effective 5% repatriation tax of George W. Bush at that time to be very effective for the economy, and companies that used it, did not hire new employees. Money went to shareholders, rather than job creation.
This time the combination of policy proposed by Trump is different. He wants to accompany 10% rate with substantially lower domestic corporate rate of 15%. Could this provide a greater incentive for multinationals to move and then keep their money in the US for longer?
CAT AND MOUSE GAME
If Trump can win, company strategists will consider whether he can stay in the office for more than just one term. If the answer will be yes, then chances for bigger repatriation will be much higher. On the other hand it is not very probable companies will move trillions at 10% rate for a relatively short period.
This means repatriation may not happen that quickly, or at all, even if proposed and additionally incentivized. It could be more of a wait and see approach by multinationals. Therefore, Trump’s plan is a high risk high reward plan without certainty in maturity match on the capital flow side.
Consequently, spot markets will probably interpret Trump’s win as a very high deficit increase on the front end of the curve. Even if it might work on the long run, Mr. Trump runs a great risk of short to mid-term USD dollar imbalance. He will need a lot of USD to fulfill the plans of infrastructure rebuilding.
In the meantime, markets will not wait. Even if Trump will see money start pouring in, it could take more time for the effect to develop and capital flows to balance out. During the process he will need to sell a lot of US Treasuries and increase debt if he will want to stay on course. From this perspective it is very obvious that in a scenario of a Trump win short term risks for the US Dollar are very much to the downside.
If Hillary wins, then the equation will be different. Her tax increase proposal and more financially balanced approach on the short term will create a lack of available USD. When the majority will need to pay higher taxes, a lot of people will need USD. Therefore USD could be in demand very quickly if she wins.
EURUSD ON ELECTION NIGHT
If big players in the market can see this, in an event of a Trump win they will take the opportunity and push USD lower very quickly first and ask questions later. Perhaps they will even be willing to repatriate to USD later, when USD rate will be much more attractive. Therefore, it would not be too shocking to see EURUSD moving higher very quickly and very substantially during election night.
In a Brexit style move, which could become even more pronounced for EURUSD than it was for GBP during Brexit, the pair could spike by more than 20%. We need to take into account that EURUSD has been range bound for over 18 months. The center of the EURUSD flow stands at approximately 1,11.
Even on technical factors alone any break out of the range could accelerate the trend. Therefore, in a sequence of potentially massive stop loss flows above 1,20 and the movement underpinned by the confusion and panic after the results will come in, things could get ballistic. Even 1,40 or higher in EURUSD will not be off the table before things settle down.
If we judge the election result by the number of participants in candidates’ rallies, then Trump will win. But Hilary on the surface appears a much more moderate politician, appealing to a broader center. Her win is not ruled out of course. Importantly, her win could have a big effect on the dollar markets as well.
Technical picture does not have a favorite in this race. If Hilary wins and her tax increases indeed would create a lack of USD, then stop loss orders could be triggered on the downside. If EURUSD rate will dip below 1,03, it could quickly move lower to under 0,95 and even to 0,90. All in all, the certainty of an outcome will trigger a very strong impulse in the market into one direction or another regardless of who wins.
As stated, if Hillary Clinton becomes the next president of the United States of America, EURUSD could react with a minus 20% move. Because her plan is more balanced on the very short term, the effect could be less pronounced and the trend could be more continuous and gradual with greater liquidity at every point. The trend in this scenario will probably be more like other moves we have seen during history.
However, risk equation is tilted toward the upside for EURUSD. If Donald Trump becomes the next president of the United States, then the move in EURUSD to the upside could be historic. The potential gap in funding, that could emerge, could catch even a lot of professionals by surprise. EURUSD could spike by more than 30% and could even follow through higher by much more than that if things get out of control. In this case there are many unknowns.
What is in each player’s interest is a pure speculation. There are no strong indications that the US Dollar rate is on Clinton’s mind. It appears to her this is not a frontal issue and she is not playing the market directly or indirectly in this sense. Not on her own at least.
Nevertheless, if we can read between the lines a lot of Trump’s comments about renegotiating debt US with China, then perhaps a substantially weaker dollar and even Treasury Bond prices on the short term is what Trump is actually playing for. Ironically, it could even be a part of the deal with multinationals and the repatriation flows. It would make a 10% repatriation rate cheaper than it appears to be at first glance.
Again, this is wild speculation, but as such it does not surface when one contemplates a Clinton win. If Trump is a world class deal maker, then EURUSD could be his biggest instrument for one of the largest transactions in history. He could bring in a lot of money in, which is currently waiting off shore. He needs the right circumstances and if he has a plan in this direction, then the profits could be raining on banks and brokers and the US Treasury all at the same time.
The pain will be left to unprepared speculators in the market. Investors need to be very careful and closely watch the developments on Tuesday night. In any case, a high probability exists EURUSD will finally break out of the stubborn range in a spectacular fashion.