Until Friday, the first debate of the 2020 US Presidential election dominated headlines. As expected, the debate provided voters with little edification, illuminated nothing about the candidates’ policies, and created a lot of heat.
With less than thirty days before polls open, Tuesday’s spectacle reflects the increasing rancour of the contest. Yesterday, market participants weighed up the risks of an inconclusive election result, with esoteric market indicators reflecting their fears. This development can be summed up in one word; messy.
To contextualise market participants’ thinking, we delve into a critical market indicator which reflects how investors are analysing events as we enter the final furlong of the Presidential race.
Additionally, we take a look at the early market reactions to the news that President Trump has contracted COVID-19.
The ‘Fear Gauge’
The Fear Gauge, as it is termed, is based on futures contracts linked to the Chicago Board Options Exchange Volatility Index (VIX Index or VIX). Briefly, the VIX index provides a snapshot of the market’s expectation of future price volatility of the headline US equity index. It reflects investor thinking about volatility over the next 30 days, and works as follows:
- Volatility of the S&P 500 index is estimated by aggregating the prices of multiple ‘call’ (right to buy) options and ‘put’ (right to sell) options on the S&P.
- Sharp and elevated market price falls indicate investor nervousness, and this pushes overall values of the VIX Index in an upward direction.
- During more serene market environments, the value of the VIX Index retreats.
- As a broad rule of thumb, VIX values above 30 generally indicate excess volatility and heightened investor anxiety, while values below 20 coincide with market stability.
VIX futures can also project further into the future. Turning to Graph-1, we map out VIX contracts with different expiry dates. We can see that investors are anticipating heightened volatility in the period around the election result, and for a period beyond November the 3rd.
Graph 1: Chicago Board of Exchange Volatility Index Futures
Source: Bloomberg, data as 02/10/2020
While election events generally coincide with periods of raised volatility, the higher levels (above 30) indicated by Graph 1 persist until early 2021. The sustained level of volatility suggests investors are expecting a protracted period of volatility in the immediate weeks after November.
Investors’ expectations of political volatility are especially meaningful in the current political climate. Negotiations between Republicans and Democrats over the provision of further fiscal support have become protracted, with neither side ceding much ground.
The market reactions in the immediate aftermath of the White House’s confirmation of Trump’s positive test for COVID-19 contraction somewhat reflect these fears, with different asset classes acting differently. An examination follows below.
Trump Catches COVID
Graph 2 depicts the movements of the 10-Year US Treasury yield in the period leading up to and after the announcement from the White House. US Treasuries are considered haven assets by investors. As we have explained in previous articles, bond yields and prices have an inverse relationship, with falling yields indicative of rising bond prices and therefore investor demand.
We can see that the yield on 10-year Treasuries reached 0.72% this week, before falling below 0.66% by Friday afternoon. Yields fell modestly from 0.68% before the White House’s announcement, to 0.66% by 7:00 am Greenwich Mean Time.
Graph 2: US Treasury Yields
Source: Bloomberg, data as of 02/10/2020
Meanwhile, Graph 3 depicts how the price of gold, another haven asset, responded to the news. The graph displays how the price of gold reached over $1900 on Friday, rebounding from a recent dip in the value of the precious metal.
Graph 3: Gold Spot Price ($)
Source: Bloomberg, data as of 02/10/2020
The slightly differing reactions from gold and Treasury investors suggest market participants were still trying to establish the broader implications of Trump’s diagnosis. The diagnosis injects an additional element of drama into the final few weeks of the Presidential campaign.
Of more consequence to the US economy is the failure of Congressional leaders to agree to a stimulus package, especially as recent data points to a slowdown in the US jobs recovery.
However events pan out over the coming weeks, we will continue to provide insight and explanations as they occur.
Conclusion
A contested result is one potential outcome of the US Presidential election and is becoming more prevalent in the minds of investors.
Investors are prudently assessing all eventualities, lessening but not eliminating the adverse effects of a messy result if it occurs.
While a contested electoral result is a sub-optimal outcome, it is not entirely unheard of. The most recent example occurred in 2000 in Florida, where ballot papers had incomplete holes punch in them, the so-called ‘hanging chads’ affair.
Investors differing appetites for different haven assets on the news of Trump’s COVID-19 contraction reflects market participants were still attempting to digest the implications in the immediate aftermath.
Recent jobs data highlights the necessity for an additional stimulus package.
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