Key U.S. markets now appear to be pricing in the risk of a delayed or inconclusive result from the upcoming presidential election, according to fresh analysis from JPMorgan Chase & Co.
Pricing for volatility protection in interest rates -- where investors trade and hedge bond exposure through various derivatives -- is “very high relative to the same stage in previous cycles,” strategists led by Joshua Younger said in a note published on Tuesday. Both over-the-counter derivatives and options on U.S. Treasury futures show volatility priced at about six times its normal level, compared with a rate of two times normal in the 2008 and 2012 presidential elections and three times in 2016, when Donald Trump surprised pollsters by defeating Hillary Clinton.
Meanwhile, the cost of hedging exposure to U.S. corporate bonds also shows investors paying more for protection than in previous elections -- including preparing for price moves that could stretch beyond the Nov. 18 expiry of one popular options contract. “Timing of election credit vol is spilling over into December,” the analysts wrote, suggesting “that credit market participants are increasingly pricing in the odds of election results being unclear by November expiry.”
The positioning in rates and credit mirrors some signs of unease in the equity market, where one popular trade involving futures tied to the Cboe’s Volatility Index shows investors now paying a record volatility premium around the time of the U.S. election on Nov. 3. UBS Group AG’s Stuart Kaiser said the implied S&P 500 move using Nov. 2 and Nov. 4 expirations is around +/-2.5% -- and 4.5% using the Nov. 20 options, which he says assumes a more extended period of high volatility.
“Despite the fact that elections, even for President, have not been a reliable catalyst for volatility in the past, a wide range of asset classes are already pricing historically high event risk into options markets,” Younger wrote in the note. “U.S. rates, credit and equities are all pricing elevated risk of a delayed or inconclusive result.”
One market that doesn’t appear to be paying-up for volatility protection is currencies, the analysts added. Volatility pricing on major currency pairs shows “complacent” positioning around the election, which may make currency trading a cheaper way of hedging political risk compared to rates, credit or stocks.
Investors have been placing election-related bets earlier than usual given a polarized political climate, with an RBC survey showing that the American presidential election is now the biggest worry among institutional investors. JPMorgan’s Marko Kolanovic, who contributed to Tuesday’s note on volatility, warned on Monday that investors should prepare for Trump winning re-election.
“The post-election FX vols deserve more attention,” the JPMorgan strategists led by Younger said. “Delays in getting the results are atypical for the U.S. elections but can occur, as seen in the 2000 election cycle. Despite the steady stream of news headlines and the fluid developments around the U.S. Postal Service the lack of pricing of a risk from a delayed and/or contested results is somewhat surprising.”
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