Market reaction to US poll result is less predictable than it seems

While the immediate market reaction to the US poll might be predictable, the longer term impacts are more complex.

With one day to go until election day, Hillary Clinton is campaigning in Pennsylvania, Michigan and North Carolina. (Justin Sullivan/Getty Images/AFP)

The obvious correlations between financial markets and the ebbs and flows of the political fortunes of the US presidential candidates appear to lead to a clear conclusion about how those markets will respond to the election outcome.

Depending on the time horizon, however, what might appear obvious from observing the markets in the lead up to the election may not necessarily eventuate or, if it does, be sustained.

It was very apparent from the markets’ reaction to the FBI’s statement that there was no new evidence in the latest trove of Hillary Clinton emails it had investigated that the markets saw that news as a boost to Clinton’s prospects of victory, just as the initial news that the investigation had been reopened drove markets down.

Indeed, throughout the campaign that ends overnight, markets have shown direct correlations with the perceived shifts in the standings of Clinton and Donald Trump.

Generally, when it has appeared Clinton is the probable winner, equity markets have risen, bond prices have fallen, the US dollar has strengthened and gold prices have fallen. Conversely, when Trump has closed the gap, shares have fallen, bond prices have spiked, the dollar has weakened and gold prices have risen.

Volatility in markets has risen and fallen sharply in line with Trump’s prospects — last week the VIX index, which measures market volatility, spiked to its highest levels since the UK’s Brexit vote on the news that the FBI was reopening its investigation. Yesterday, the index fell back to levels below its long-term average.

The two currencies other than the dollar that have provided the clearest indicator of the shifting odds have been the Mexican peso (because of Trump’s wall and the possible implications for the North American Free Trade Agreement) and the Japanese yen, which is seen as a “safe haven” currency.

Should Clinton win, there will probably be a continuation of the “relief rally” in markets: stocks, bonds and the US dollar up, gold and the yen down. That rally may, however, be short-lived.

The markets fear Trump because his policies are erratic, protectionist and isolationist. They would cause massive trade frictions, wind back globalisation and threaten world economic growth. They would also create significant geopolitical uncertainties and risk.

The markets prefer Clinton because she is a known and competent quantity with developed policies, even if there are some taxation and spending policies that the US markets would normally abhor. A Clinton administration would be more predictable and conventional than one with Trump at the helm.

Past elections have shown, however, that while there can be quite significant immediate market reactions to the outcome it’s usually a short-term effect.

The US stockmarket fell quite heavily after the 2008 and 2012 elections won by Barack Obama but (aided by ultra-low US interest rates, thanks to the Federal Reserve Board’s unconventional monetary policies) it has had a remarkable bull run through those two terms.

Once the dust settles, Clinton’s tax-and-spend approach might unsettle the markets.

More particularly, a Clinton win would sharply increase the prospect of the December rate hike in the US that the Fed has recently been flagging. That could reignite global markets volatility and lead to rising yields and falling bond prices in the US.

A Trump victory would, after the knee-jerk reaction was digested, make a Fed move much less likely and therefore would tend to support equity markets.

In the near term, his plan to cut corporate and personal taxes might be regarded as a positive, even though it would lead to a massive increase in already swollen levels of US government debt in the longer term. There are credible estimates that his plans would add $US5.3 trillion to the existing $US19.5 trillion of US national debt.

His politicisation of the Fed and its chair, Janet Yellen, who he has accused of keeping US rates low to help the Democrats, would undermine the Fed’s credibility and create question marks over both Yellen’s future and that of US monetary policy. If he wins, the prospect of a US rate hike in the near term probably evaporates.

It is likely, given his unpredictability, that the early phases, at least, of a Trump presidency would generate enormous volatility in markets. Markets loathe uncertainty, which equates to risk.

However, while the recent fluctuations might seem to point to a sell-off of all things US in the event of a Trump win, in the longer term will investors want to park their capital in the safe haven of yen-denominated assets, in a recessed economy with a negative rate environment? Ditto the eurozone. Asia would be battered by Trump’s protectionism.

There would be nowhere for investors to run or to hide, which would almost certainly mean their funds would flow towards gold and the other traditional safe haven — US Treasuries. US rates would probably be falling, not rising.

Thus, while the markets’ immediate responses to the election outcome might be predictable, the longer term impacts are more complex, less predictable and perhaps even counterintuitive.

What looks like the likely outcome — a Clinton presidency — means US economic and trade policies and its global strategies would at least be framed by familiar and conventional reference points. If Trump were to prevail and pursues the policy directions he’s outlined, the whole world is in for a bumpy ride into territories uncharted in the post-war era.