Big moves, but no panic after tumultuous US election

Treasury market saw its largest post-election move since at least 2000 – but liquidity held up

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The US election scenario financial markets most feared became a reality in the early hours of Wednesday morning: US president Donald Trump and Democratic challenger Joe Biden were virtually deadlocked in the race for the White House.

The market response was surprisingly sanguine. There were big moves – but none of the predicted chaos.

The S&P 500 gained 3% in morning trading on Wednesday. The Vix index of S&P 500 options volatility – a barometer of fear and uncertainty – shed six points to trade below 30 for the first time in over a week. Ten-year US Treasury yields dropped 19 basis points overnight.

“There’s quite a lot of activity going through, but there’s no panic,” says an equity trading head at a US bank. “The US flow is quite bullish.”

One reason is that a delayed and disputed election result – while not expected – had been well flagged as a plausible outcome. “One of the benefits of looking at scenarios beforehand is that we were not surprised,” says Andrew Chin, chief risk officer at Alliance Bernstein. “Markets don’t like surprises and since we talked about potentially not knowing the outcome for days or weeks, the markets are OK with it.”

An analyst at a European bank agrees: “This is not where the market expected to be, but unexpected doesn’t mean unprepared.”

And the market also found at least one silver lining in the results: the increased odds of Republicans holding on to the Senate majority took some uncertainty off the table.

“Because the government looks like it will still be divided, we have a better sense of how things will likely play out,” says Chin. “A democratic sweep would have produced more uncertainty [on policies to be enacted] so the market has more clarity on the gridlock that will likely occur on everything.”

The likely division of power could put the brakes on the hefty stimulus spending that was anticipated if Democrats gained control of Congress. That spelled trouble for investors that had put on curve steepeners in anticipation of a ‘blue wave’. The trade involves buying short-term Treasuries and shorting longer-term securities.

Because the government looks like it will still be divided, we have a better sense of how things will likely play out
Andrew Chin, Alliance Bernstein

As it became clear that Republicans would hold on to the Senate, the chances of a beefy stimulus – and a steeper yield curve – diminished. A subsequent unwinding of these trades started in Asian hours, with real money accounts responsible for the bulk of the volume. “There was just a significant amount of de-risking of investor portfolios in fixed income. An initial trickle of Treasury buying turned into a torrent last night,” says a US rates strategist. “That same flow happened in New York, too.”

Investors started piling into long-term Treasuries. The strategist reckons it was the third-highest volume day on record, behind only Brexit and the 2016 US presidential election, based on the interdealer broker flows he could see. Futures markets also saw a big surge, with the 30-year and 10-year bond options contracts seeing the second-highest volumes on record for an overnight session, according to CME.

The 10-year yield fell 19 basis points overnight, while the 30-year saw a 23bp drop. According to Tradeweb, these were the largest post-election moves since at least 2000.

Investors holding steepeners saw hefty losses. The spread between two- and 10-year US Treasuries collapsed from a peak of 73bp earlier on election day to 64bp by midnight, and then dropped another 1bp the following day. The spread between five- and 30-year Treasuries fell from 133bp at 19.18 ET on November 3 to 122bp by 21.39 ET.

“The market is hurting,” says one fixed income quant at a trillion-dollar asset manager, who watched the flows as the night unfolded.

But unlike in March, when liquidity in US Treasuries deteriorated to a point where the Federal Reserve had to step into the market, investors were able to unwind these steepener trades without a hitch and put on the reverse trade, a flattener.  

And despite the pain these investors were feeling yesterday, the move did not wipe out their recent gains. The spread between two- and 10-year Treasuries is still 24bp wider than it was in late August, while the five-year, 30-year spread is 27bp wider than it was in late July.

Pavlovian response 

The big bet in currency markets was on a weaker US dollar – particularly versus the offshore Chinese renminbi. The thesis was that a Democratic sweep would result in not only a large stimulus package but also an easing of trade tensions with China. The Chinese economy is also expected to rebound faster from the Covid-19 pandemic than the US.

Traders unwound some downside USD/CNH trades early morning, London time, but trading was muted thereafter. “When the early results indicated [a strong showing for Trump], the market spiked to include USD strengthening trades,” says Antony Foster, head of G10 FX spot trading for Europe, the Middle East and Africa at Nomura. “The London session has seen a reversal of this, given that Biden is now more likely to win, but participation has actually been quite low considering the uncertainty.”

Geoff Yu, senior EMEA strategist at BNY Mellon, confirms that trading has been subdued. “Most activity is actually concentrated around squaring positions which whipsawed during the early hours,” he says.

“The dollar has given up some of its early gains,” Yu adds, while “the renminbi has recovered some of its early losses, and is now moving past US election news.”

An FX options trader a European bank says client flows were balanced through most of the day and that liquidity was “adequate”.

For much of the day, investors seemed to be on auto-pilot. Tech companies led the move in equities, with the Nasdaq 100 up over 4% at one point. It was the kind of move analysts expected to see in the event of a Trump victory. But Alexander Altmann, head of equity trading strategy at Citi, says tech exuberance has practically become a reflex response to plummeting Treasury yields. 

Most activity is actually concentrated around squaring positions which whipsawed during the early hours
Geoff Yu, BNY Mellon

“There was definitely a Pavlovian response for investors to just buy what they know. If 10-year yields are staying low, investors just pull back into the same companies, bearing in mind these businesses underperformed going into the election,” says Altmann. 

“If anything, what we’ve seen is this massive flight to safety, so you’re seeing large caps dramatically outperform small caps. And anything with a strong balance sheet is significantly outperforming anything with a weak balance sheet. But we’re talking about numbers here that I would say are very knee-jerky.”

Others say the bullish tone reflects widely held expectations that a winner will emerge without a protracted legal battle. A recent Risk.net crowd-sourced scenario generation exercise, in conjunction with RiskThinking.ai, suggested a contested election could be a disaster for markets. In the scenario deemed most likely following a contested election, the S&P 500 collapsing to 2,100 by late January, while 10-year Treasury yields plunge to 0% and the dollar tumbles to a post-crisis low of $1.40 against the euro.

Trump declared victory in the early hours of Wednesday morning, before key swing states had been called, and vowed to take the fight to the Supreme Court. His campaign has indicated it will seek a recount in Wisconsin and has already filed lawsuits in Pennsylvania and Michigan. But Citi’s Altman says the courts are unlikely to decide the result.

“Even though we’ve got an unclear election outcome at present, it looks like the path towards a contested election remains, from what we can see, relatively low.”

This partly comes down to arcane electoral laws in states where the contest is close to the wire. Wisconsin and Nevada – two key battlegrounds – have 0.5% thresholds for automatic recounts. As of Wednesday afternoon, Biden led both states by 0.6 percentage points. Pennsylvania – the largest state yet to be called, with 20 electoral college votes up for grabs – may prove difficult for Trump to contest given it has a Democrat leaning Supreme Court.

Traders say the market can continue to function calmly for up to a week without a decision. After that, more volatility is expected to materialise. A London-based trader at an international bank warns against complacency. “With Trump, anything is possible, and he could go down the legal route and stir up his supporters which could cause social unrest.”

The head of risk at a European bank sums up the feeling in markets: “It’s as if everyone is waiting.”

Additional reporting by Lukas Becker, Costas Mourselas and Tom Osborn

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