Financial market consensus on Tuesday had moved emphatically towards the prospect of Hillary Clinton winning the presidency, with credit, equities, rates and FX all reflecting confidence in that outcome. But as US state-by-state results rolled in, that certainty evaporated and derivatives asset classes made a sharp about-face.
“It’s a historic day — the biggest political upset in American history,” said Léon Cornelissen, chief economist at asset manager Robeco. “It’s clear that US voters have chosen a candidate preaching disruption and have scoffed at continuity. It can be seen as a massive anti-establishment vote along the same lines as Brexit, where voters are basically fed up with the status quo.”
But traders had suggested on Tuesday that optimism for a Clinton victory was tempered by the experience of the Brexit vote in June. And they reiterated this view on Wednesday, as markets digested the Trump shock.
"Everyone hedged well going into this," said one equity derivatives official at a bank in London after close of business on Wednesday. "That pressured volatility today, because they monetised their protection quickly as is often the case in these situations. That does of course run the risk of getting caught short if things do really start to move around after this."
Another mitigating factor is that the Trump victory makes a US rate rise in December look much less likely, while the previous consensus on a Clinton win had placed a hike as virtually priced in.
“There is more uncertainty for the US than Europe in the short term,” said one credit official at a bank in London. “The odds of a rate hike this year have plummeted by two thirds. Why would the Fed now want to press ahead with that amid so much uncertainty? Domestically Trump could enact aggressive fiscal spending, which should be supportive of US credit and equity, but he has also been highly critical of the Fed and that could play out in the coming months.”
Other sources challenged the notion that a rate hike would be delayed by Trump's win, however.
"Our house view is still for a December hike," said one equity strategist. "Unless markets start to suffer then I see no reason why the Fed would change its course."
And the election vote does raise other concerns wider afield than the US, said sources.
"It also has big implications for global politics too," said one FX strategist. "If he [Trump] can win using the unconventional tactics that he used, then no doubt others around the globe will try to do the same. Following on from the Brexit vote, this makes it more likely that the Italians reject the referendum in December and I think may strengthen Le Pen's hand in the French elections next spring."
S&P 500 index futures fell 5% ahead of the London market open and the VIX volatility spiked 3%, to 21.5%. Meanwhile the Japanese yen soared back to near its early October highs against the US dollar, while the Mexican peso plummeted well below the year’s previous lows, with the dollar rising from MP18.25 to MP20.75.
“Markets are swooning from uncertainty,” said Societe Generale in a cross-asset research note on Wednesday morning. “S&P500 short-term risk is down to 1950, VIX could reach 25%-30% level and stay there for a while, but light net long positions on the US equity index prior to the election do not argue for more.”
European credit derivative indices reflected the market shock at the London open, with iTraxx Europe widening 9bp to 82bp and Crossover some 35bp wider to 360bp. Financials credits took the brunt of the investment grade sell off in credit, with the Senior Financials basket widening 12bp to 108bp. Financials also underperformed other sectors in European equities.
But by this stage, other asset classes had already relaxed back some way from their immediate kneejerk levels and credit followed suit. The Main index reverted to 76bp, just 3bp wider from the Tuesday close, and Crossover returned to 338bp and Senior Financials to 101bp. The yen returned above $103.5 and the dollar to below MP20. VIX went back below 20%.
“It really has been fairly orderly,” said one credit official at a bank in London around midday UK time. “Main has come back and Crossover has retraced much of its initial widening. Volumes have been strong, as you’d expect for any event like this, but beyond the initial reaction there is a feeling that things will take a while longer to play out in Europe. It’s not as immediately disruptive as Brexit overall and credit could also benefit if people roll into bonds to limit downside risk.”
By close of business on Wednesday, the Main index had tightened back further, inside 73bp, while Crossover was at 328bp and Sen Fin at 96.5bp. This put the three indices largely flat on the day.
VIX, meanwhile, was back below 16% by close of business in London. The Mexican peso maintained its elevated levels against the dollar, however, and the yen climbed steadily against the dollar. Dollar / yen was quoted at 105.25 again near the London close.