How will the US election affect financial markets?

The US election is less than three weeks away, with the outcome seemingly pivotal to the outlook for the US economy, the spillover to the rest of the world, geopolitical tensions, and more. But the outcome of the election seems genuinely impossible to predict. How can we expect the market to price in a seemingly crucial event without any sense of the outcome?

The most obvious answer is that financial markets will price in a good deal of volatility over the election event, but without any significant directional skew or bias. This is the market basically saying that it does not know what the outcome of the election will be, but if you want to take a position on the outcome, it is going to cost you more to do so if you choose the options market.

Indeed, if we look at one-month implied volatility levels in currencies or bonds, we see that there’s been a notable rise although, as far as we can tell, the market is not going overboard here. In other words, it looks as if the market is priced for volatility around the election announcement but not necessarily priced for a significant directional move in asset prices thereafter. This being said, it is not as if the markets have eschewed all directionality.

In the FX market, risk reversals have become a better bid for US dollar calls relative to puts over the one-month horizon. Of course, part of this is down to the fact that the US dollar itself has been rising recently, and we’d expect the risk reversals to follow. However, it might also reflect the fact that, while we cannot predict the outcome of the election, there’s a possible asymmetry in the impact on the dollar when the results are announced.

“What we mean is that a Trump victory would likely be seen as a positive factor for the dollar and yields, at least initially, while a win for Harris would not necessarily be seen as very negative. This apparent asymmetry lends itself to the notable bid for dollar calls relative to puts that we are now seeing,” said Steve Barrow, Head of Standard Bank G10 Strategy.

If the pre-election situation seems to be one in which the US dollar and US yields are quite stable, with movement constrained to the options market instead, the passing of the election could see this flip around with the US dollar and yields moving more while option volatility eases down. Quite clearly, the victor in the election will likely have a substantial bearing on the extent of the directional move we can expect in the dollar and yields.

As just explained, a victory for Republican candidate Trump would likely lead to a far more significant initial market response, and particularly if Republicans take a clean sweep of the House and Senate as well. In contrast, victory for Harris will likely see a far more muted reaction, especially if Congress shirts Republican or if it remains divided. The question that then arises once the result is known and the market has got over its initial reaction is whether the outcome requires a longer-term response from the market.

For instance, is it likely that a victory for Trump will leave the new president able to push through most, if not all, of the policy promises made in the run-up to the election? The key here, at least on tax cuts, is whether the Republican Party takes control of Congress. If the market concludes that many, if not all, of the election promises made by Trump (or Harris, for that matter) are likely to be delivered, we may find that the initial post-election reaction intensifies.

“In the case of a Trump victory, any knee-jerk rally in the dollar and Treasury yields straight after the result could continue should the market start to price in the real prospect of most, or even all, of Trump’s promises being fulfilled, for instance through the Republicans taking Congress as well, and perhaps Trump restating his intentions in areas such as tariffs and deportations. In short, the more speculative short-term traders will clearly strike fast when the election outcome is known, but whether longer-term, more strategic investors join in may depend on more than just the outcome of the presidential election itself,” said Steve Barrow.