US: Election mispricing is the dishevelled retreat – Deutsche Bank

Alan Ruskin, Macro Strategist at Deutsche Bank, suggests that the Monday’s activity provided some strong clues on potential FX price action were Clinton to win the Presidency.

Key Quotes

“The market response strongly suggests that while a Clinton victory will play moderately USD positive versus G4 currencies, favored EM long carry trades financed by the USD and the other majors will continue to do well.

If Clinton is elected the next President, in the 24 hours following the election, we would broadly anticipate a repeat of the percentage changes achieved on Monday. Follow-through beyond that will likely prove limited.

On the flip side, a Trump victory would in the initial instance, probably lead to a reversal of Monday’s FX moves, but likely multiplied by a factor of at least two times for G4 currencies, and at least three times for EM and higher beta currencies.

The question, however, is whether currencies are now underpriced for a Trump victory? Obviously this is in part contingent on the probability attached to a Trump win. One way to assess this is to look at the strikes on a zero cost risk reversal - calculated by matching a 25 delta call against a put struck at a price that implies zero cost.

Zero cost risk reversal strike ranges that look like they have a Clinton victory covered, but not a Trump win, include: USD/JPY, USD/CAD, and pretty much all USD/EM, notably USD/MXN and USD/CNY.

As an example, in the next week, USDJPY likely does not have scope to immediately run much above Y106 on a Clinton victory, but could easily head well below 102.40 on a Trump win. On a Trump win, USD/China could easily follow the course seen after Brexit, where CNY weakness was tolerated while the market was distracted with other events. Riskies extending beyond a week are preferred here. Among the stand-outs over the past 24 hours, is the subdued reaction of USD/CAD relative to the kind of move priced in by O/N vol for the election. The reasoning is that on a Clinton victory USD/CAD is caught between two opposing forces.

On the one side, Clinton is associated with a stronger USD versus the G4 majors, not least because a December Fed rate hike is more likely. But this is counterbalanced by a Clinton ‘risk on’ move helping the CAD while similarly, Clinton’s stance on NAFTA is also seen as CAD positive. Don’t expect such restraint, if Trump wins and drives both a risk off move, and a real threat to NAFTA.

Similarly on USD/MXN, over the next week, spot is not expected to spend any extended time below 18.00 even on a Clinton win, while 25 delta call strike just below 19.5 will likely be exceeded by some margin over a week on a Trump win, even with Banxico contingency plans.”