US: Trump making gains will soon worry markets - MUFG

Derek Halpenny, European Head of GMR at MUFG, suggests that the focus is perhaps still on monetary policy with both the Fed and the BoJ announcing monetary policy decisions next Wednesday but once these events are behind us we may well see a more notable shift in focus to the US presidential election which is beginning to heat up.

Key Quotes

“Last week 2-month FX volatility in a number of key currency pairs jumped as the election result came within that timeframe. USD/MXN 2-month implied volatility surged last week to levels we haven’t seen since 2011 when the euro-zone debt crisis was hitting EM FX globally. This week increased risk aversion, despite receding expectations of a rate hike next week, was perhaps in part due to an increased focus on the election uncertainty after Hillary Clinton’s “medical episode” at the 9/11 memorial ceremony on Sunday.

We outlined the ‘narrow road’ to the White House that exists for Donald Trump. While it is far more difficult for Trump than Clinton, our sense is that the financial markets may soon start to price this ‘narrow road’ scenario more seriously, resulting in increased financial market volatility. The election objective for Trump appears to be pretty straight forward – repeat the number of states won by Mitt Romney in 2012 and then take the key swing states of Ohio, Florida and Pennsylania from the Democrats.

The state-by-state polling on RealClear Politics reveal that both Florida and Ohio are too close to call and certainly within the grasp of Trump. He’s ahead in Ohio by an average of 1.0ppt and ahead in Florida by 0.7ppt. The greater problems currently for Trump are winning Pennsylvania – the last Republican victory there was way back in 1988 – and holding North Carolina given that Clinton is ahead in both of these key states.

Trump has new key personnel leading his campaign team since last month and there has been some change in tone of late and if Trump can avoid major gaffs that have cost him dearly in the polls over the past six months then a Trump victory doesn’t appear as implausible as many assume.

The Mexican peso is the worst performing free-floating LATAM currency so far this year and the surge in implied volatility last week over the election period highlights the potential fallout for the FX markets. Other LATAM FX vols also jumped markedly but to a lesser extent than MXN while CAD vol jumped but from very low levels.

While the dollar would advance in the EM FX space, in the G10 space, the dollar would likely suffer. For the yen in particular given its large current account surplus that is dominated by an investment income surplus rather than a trade surplus, we would expect to see marked gains as investors fear an orchestrated attempt by a Trump presidency to weaken the dollar. We will be watching state-by-state polling in those few key states closely over the coming weeks.”