Time to crank it up a gear

As we prepare to take on the deluge of major event risk over the next two weeks, the general feeling on the floors today is positive and there is little sign of worry or derisking.

US equity has closed broadly higher (the S&P500 closed +0.3%), with small caps leading the charge (the Russell 2k closed +1.6%), and while we’ve seen a bit of a chop fest in the intraday S&P500 tape, financials have found the love and led the way. Gains were broad-based though, with 70% of S&P500 companies closing in the green, with energy unsurprisingly the underperformer.

Tech and growth equities have taken a backseat, with value and high dividend plays as the factors that have attracted investor and trader flows on the day. That may change with AMD due to the report tomorrow, potentially offering further insights to solidify earnings expectations for other semi-plays due to report in the period ahead. However, the trade that seems to be getting attention is to be long financials – including smaller and regional US banks (KRE ETF +3%) and to marry that against long tech exposures – a ‘barbell’ strategy, which works when financials get the love, and when traders switch into tech/semi/AI.

Value outperforms with US election hedging also in play

Value – as a factor- typically outperforms by some measure around US election periods, so it’s no surprise to see this factor working well on the day. Getting set in equity factors to tackle the election is one play, but traders also continue to hedge out US election risk through the options channels, and while some will look at the lofty 10-volatility premium the VIX index holds to 20-day realised volatility, the better way to look at election hedging in US equity is through the shorter-dated equity options.

Here we see a 7-volaility premium for the implied volatility for Russell 2k ATM 6 November expiry to that of the implied volatility in the 4 November expiry. While not as pronounced, we can see a 3 vol premium in the implied volatility for S&P500 6 Nov ATM options over 4 Nov options - That’s a decent jump in implied volatility in options volatility that expire after the election than before, suggesting a fair degree of US election risk premium priced into equity.

FX implied volatility is sky high

We can see an even more pronounced degree of election hedging in US Treasury and FX options markets. Notably, the implied volatility for 2-week USDCNH (offshore yuan) options sits at a record premium to how USDCNH volatility has been realised over the past 2 weeks. Other Trump tariff proxies EURUSD and USDMXN hold the largest premium for 2-week implied vol vs realised since 2016 and 2017, respectively.

Given that options market makers use realised vol as the basis for pricing expected/implied movement, these mentioned differentials speak volumes as to how traders see the election playing out through the FX channels.

Hedging aside, on the day we’ve seen a mixed affair across G10 and EM FX, with USDJPY trading into 153.87 post Japan’s Lower House election result, and then pulling back to 152.41 before the buying kicked back in – those trading USDJPY on the day would have had to be nimble to tackle that tape, with the spot rate going on somewhat of a wild intraday ride. We see small gains in EURUSD and GBPUSD on the day, despite US Treasury yields rising yet again, and the swaps market pricing out 5bp of cuts for the Fed’s terminal rate or the expected low point in the Fed’s cutting cycle.

While US economic data was minimal on the day, bond traders had to navigate a soft 2-year US Treasury auction, and later the US Treasury Department’s Quarterly Refunding Announcement. The QRA detailed a modestly reduced funding requirement of $546b for the Oct-Dec quarter with a net $823b in borrowing in the Jan-March quarter.

An ever-increasing focus on long-end bond yields

The world clearly is paying ever-greater attention to the US and other DM bond markets, and notably the longer-dated maturities. In a world of ballooning fiscal deficits, while the UK and France may be trying to address their fiscal issues at the expense of growth, we look notably towards Japan and the US, where further fiscal stimulus may result in the bond market taking them to task – obviously, in the case of the US, a further blow out in the fiscal balance would hinge on a ‘red wave’ scenario playing out, and Trump playing the fiscal rollout poorly. But with the Fed still undertaking QT, moves from here, and certainly post the US election, in the 10-year and 30-year US Treasury, will get increased attention.

Crude has been well traded by clients, as is the way when any market has the biggest move in over a year. Brent settled 6% lower, with the bulk of the selling playing out through Asia and early European trade, with price hitting a low of $71.18 before trading a range into the US close. While traders have gone someway to removing remaining geopolitical risk premium, crude also has to be on the radar in the event of a ‘red sweep’ election outcome – It seems a tall order to think the US can ramp up production by a further 3 mbpd when they already produce 13.5 mbpd, but if Trump holds true to his word, then it would make for a very interesting dynamic among the major crude producing nations and almost certainly result in $60 crude.

Nat Gas closed -10.9%, again cementing its place as the market for the bravest of souls, or at least for those with a high-risk tolerance. Turning to Asia open, our calls highlight both the ASX200 and HK50 to open 0.6% higher, with the NKY225 eyeing a flat open. Certainly, if value was the play in the US, then the read-through for the ASX200 is a positive one given its status as the value and income equity index of choice for many international managers.

By way of event risk, the calendar remains on the light side in the session ahead, although US job openings (JOLTS) and US consumer confidence has the potential to impact. Good luck to all.