A glimpse on US elections, 3m FX HVs and IVs

14 September 2016, 11:39
Eko Rediantoro

The US polls currently give Clinton a 2-5 point advantage over Trump. Polls also highlight a near-record lack of trust in government, which increases the risk of a ‘surprise’ anti-establishment vote.

In the floating exchange rate regime (now more than 40-year old) the USD has done best through Democratic presidencies so far.

But, would the US polls be a large FX volatility event?

To assess the impact of the US presidential election on volatility, we reconstructed a G10 3M realised volatility index that has the same composition and weightings as the CVIX index (3M implied vol). As shown in the above graphs, the strong link between realised and implied vols, we are not strong believers in history repeating itself in OTC, but the analysis delivers surprising facts. In terms of G10 FX volatility, the elections of the past 20 years can be split in three groups: -

FX vols generally fell into re-elections: 1996 (Clinton 2), 2004 (G.W. Bush 2) and 2012 (Obama 2).

There was no clear trend into elections that led to the first mandates of Republican presidents: 1988 and 2000 (Bush, father and son).

FX vols soared into elections that led to the first mandate of Democratic presidents: 1992 (Clinton 1) and 2008 (Obama 1).

If you believe in such patterns, FX vols may be set to surge into a Clinton victory, not a Trump one. Positioning for a repeat looks adventurous, however.

First, Bill Clinton and Barack Obama took over Republican presidencies – the significant change created uncertainty. Hillary Clinton instead would take over a Democratic president.

Second, in both cases (1992 and 2008) the surge in vols was linked to market developments that were to a large extent detached from the US presidential election: the ERM crisis (European Exchange Rate Mechanism) that led to the exit of Sterling and the fall of Lehman Brother.

Following the Brexit vote that caused a large shock in volatility across asset classes, realised volatility has pulled back sharply. That fits with the concern expressed in our H2 FX Outlook that reduced central bank activism over H2 may lead to a fall in FX volatility. 3M implied vol is already trading through 3M realised but still has ample room to the downside if 1M realised continues to crash.

In contrast to the Brexit vote, where polls moved markets significantly, so far US election polls have had little impact. There has been no clear link so far between the Clinton-Trump spread and FX vols.

Despite the anecdotal historical evidence discussed above, we believe that going into the finish line, polls that look good for Clinton will tend to suppress vols, while Trump gains will push vols higher. This is because Clinton would suggest some policy continuity, while Trump would increase the chance of radical changes.

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