Cross-Asset Preview: US Elections and Fed Meeting Set to Shake Markets

As we enter a crucial week for global markets, all eyes are on two major events: the US elections on November 5th and the Federal Reserve’s meeting on November 7th. These events have the potential to significantly impact various asset classes, from equities to bonds, currencies, and commodities. Let’s dive into what investors and traders should be watching.

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US Elections: A Tight Race with Market-Moving Potential

Current State of Play

• Polls show a neck-and-neck race between Trump and Harris

• Trump has a slight lead in key battleground states like Pennsylvania and Georgia

• Prediction markets still favor Trump, but odds have tightened recently

Potential Market Reactions

Goldman Sachs outlined their expectation over the 4 possible scenarios as follows:

1. Republican sweep: S&P 500 up 3%
2. Trump victory with divided government: S&P 500 up 1.5%

1. Harris victory with divided government: S&P 500 down 1.5%

However, Bank of America’s Michael Hartnett offers a contrarian view:

• A Republican sweep might lead to an initial rally followed by a sell-off due to inflation concerns
• A Harris victory could trigger a “buy the dip” mentality as markets price in policy continuity, less upward pressure on inflation and a status Quo outcome
• Recall that in 2016 Trump was perceived as negative for markets, with large falls in the Dollar and Stocks as the results came in.
• These moves were swiftly reversed in the days and weeks following, could we see the same for a Harris win and split congress outcome?

Are We There Yet?

The mainstream press has been at pains to tell anyone that will listen that the result of the election may not been known for some days. While its true the AP (Associated press) did not call the 2020 result until the 7th of November there are reasons to expect a much faster result at least for the presidential race. But don’t take my word for it, Goldman Sachs outline some of the reasons here they include…

• Numerous changes to how ballots are counted and recieved

• Less absentee voting as 2020 was impacted by the Covid pandemic

If you need a reminder here is the timeline for the swing states…

Sector and Asset Class Impacts

Opinions are like….ok lets not go there but suffice to say everyone has an opinion on what will happen post the elections. Here are a few snapshots again from Goldmans first via their Quick Polls

• Republican victory: Likely positive for financials, energy, and domestic construction
• Democratic victory: Could benefit healthcare, infrastructure, and renewable energy sectors
• Small-caps (Russell 2000) may outperform in the medium term regardless of the outcome

So there you have it clear as mud right?

Federal Reserve Meeting: A Done Deal with Forward Guidance in Focus

• The Fed is widely expected to cut rates by 25 basis points
• Market attention will be on the press conference and forward guidance
• Any hawkish tone could be negative for risk assets, especially if combined with election uncertainty

Cross-Asset Positioning and Risks

Equities

• Hedge funds are taking on more risk than in previous elections

• The top 10 stocks now comprise 40% of the S&P 500, potentially exacerbating volatility

• S&P 500 gamma exposure is near neutral, removing a potential stabilizing force

Volatility

• VIX futures are net long for the first time since 2018, indicating heightened hedging activity

• The SKEW index suggests investors are well-hedged, but not excessively so

Fixed Income

• Some investors have been exiting long bond positions, unusual before a potentially volatile event
• This could indicate concerns about a scenario where both equities and bonds sell off simultaneously

Gold and Cryptocurrencies

• Gold positioning is extreme, with Goldman Sachs recommending a shift from physical exposure to options strategies

• Central bank buying and ETF inflows are supporting gold prices despite decoupling from real yields
• Bitcoin may show some correlation with gold as a hedge against fiat currency devaluation, but remains more volatile and correlated with risk assets

Trading Strategies to Consider

• VIX put spreads targeting a move back to the 14-15 range post-election

• Gold call spreads (e.g., 20-delta, 3-6 month expiry) to maintain upside exposure with reduced downside risk

• Small-cap exposure through Russell 2000 index or IWM ETF, end of year 240/245 Call Spreads setup well, anticipating potential outperformance
• Sector rotation strategies based on election outcomes (e.g., financials for Republican victory, healthcare for Democratic victory)

What to Watch

• Exit polls will be released starting at 10 PM UK time on election night
• Early results may skew Republican due to reporting patterns; patience is key
• Market reactions in Asia and Europe before US markets open
• Fed Chair Powell’s press conference for clues on future rate path

As we navigate this potentially volatile week, investors should remain vigilant and prepared for various outcomes. The interplay between the election results and the Fed’s forward guidance will likely set the tone for market direction in the coming months.

Remember to stay tuned to reputable sources for real-time updates and analysis as events unfold. Good luck and happy trading!