Market analysis: Fear index rises over US election

If Donald Trump wins the election, the future of Janet Yellen, the Federal Reserve’s chairwoman, could be in doubt. Andrew Harrer / Bloomberg

Just over a week ago the markets were drifting towards the US presidential election comfortable in the thought that Hillary Clinton would be elected over Donald Trump.

However, news that the FBI is continuing its investigation into Mrs Clinton’s emails has made the White House race competitive again, causing the markets to take fright at the possibility of a Trump victory. With one day to go before Americans go to the polls, markets are bracing for such an eventuality.

Mrs Clinton is clearly the preferred candidate for the financial markets as she would represent continuity in terms of economic policy. Mr Trump, on the other hand, has not really articulated a detailed plan for the economy but is believed to prefer a much more protectionist trade policy and has emphasised a preference for substantial tax cuts that could push the budget deficit higher.

It is the uncertainty of a change in policy under a Trump presidency that is triggering some of the traditional signs of investor risk aversion. The VIX “fear” index is trending back towards levels last reached just before the Brexit referendum in the summer. Gold, the Japanese yen and Swiss franc are benefiting from the uncertainty while the S&P has fallen by more than 2 per cent during the course of the past week.

So far, this drop is still a relatively muted response to the narrowing in opinion polls, but the risk is that it could fall much further in the event of a Trump win.

In this scenario, the likelihood of the Federal Open Market Committee (FOMC) hiking rates at next month’s meeting would clearly diminish and even the fut­ure of Janet Yellen, the Federal Reserve’s chairwoman, could be in doubt. The FOMC’s latest meeting ended last week and signalled that a rate hike in December was becoming more likely.

The statement indicated that the committee was waiting for “some” further evidence that inflation and employment were on track to reach their targets and highlighted a rise in inflation and inflationary expectations since earlier this year.

The October jobs data released on Friday appears to have provided “some” of the further evidence that was required, with news that the unemployment rate fell to 4.9 per cent and the average earning rate rose to 2.8 per cent, a seven-year high.

The dollar would be clearly at risk in a situation that saw consensus expectations for a December Fed tightening jeopardised by stock market weakness, and it is noticeable that it failed to rally after the jobs data. The threat of more protectionist trade policies would not do it any favours either.

The risks will not necessarily go away under a Clinton victory. The markets will also have to consider the possibility of continuing gridlock and the threat of policy paralysis if the vote results in a dead heat, prompting a recount similar to that seen in 2000 or the possibility that the electoral college overturns the winner of the popular vote.

Almost certainly, Mr Trump would dispute a narrow win for Mrs Clinton, claiming it was rigged and threatening at least a month’s worth of continued uncertainty. And even if the margin of victory is significant, much will also depend on the balance of power in Congress, especially if the FBI’s investigation into Mrs Clinton’s email turns up more evidence to justify a possible impeachment.

If these outcomes are avoided assumptions that Mrs Clinton represents economic continuity might also be mistaken. After all, she has tacked to the left on a number of issues during the campaign, including on trade, on regulations and on taxes, areas that the financial markets would be concerned about.

For the Middle East and especially the GCC the impact of the election result will be felt mostly through the financial market reaction. Equity market losses in the event of a Trump victory would transmit themselves around the world, as fears would rise of a trade war at a time when global trade is already weak.

Heightened uncertainty might result in a short-term reprieve to interest rates tightening risks, which could soften the dollar and by extension regional currencies. However, a win for Mrs Clinton, which still looks most likely, would mean a December rate hike becomes “baked in” and the dollar and GCC currencies strengthening as a result.

Tim Fox is the chief economist and head of research at Emirates NBD

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