Investors approached the US presidential election with confidence that Democratic challenger Joe Biden would win, and win big. By the end of the week, they were cheering at the prospect of a more circumscribed Biden presidency shackled by a Republican Senate.
Going into the week, the bet was on a “blue wave” of Democratic victories for the presidency and Senate. Many investors fastened on to a “reflation trade” — betting that a big fiscal spending spree would help stimulate economic growth and stir inflation, in turn hitting US government bonds.
But once again, 2020 wrongfooted investors. The forecast easy win for Mr Biden did not materialise. Democrats did not sweep comfortably into the Senate. And the blue wave trades quickly crashed on the shore.
“I’ve been doing this for almost 30 years, and politics is really really difficult,” said Vadim Zlotnikov, president of Fidelity Institutional Asset Management. “It’s almost impossible to predict the outcome, and even if you can, you have no idea what the market reaction will be.”
The “blue wave” trade neared its peak as investors sold US government debt. The 10-year Treasury yield rose to 0.87 per cent — the highest since June. The US stock market rose 1.2 per cent and the Vix volatility index declined, as some hedge funds bet that fears over post-election mayhem might be overdone.
“There is a bit of relief about Biden being ahead in the polls,” said Emmanuel Cau, head of European equity strategy at Barclays.
When results started to emerge, President Donald Trump’s unexpectedly strong early showing in a series of states raised the possibility that he might keep the White House after all, while the Democrats looked less likely to regain control of the Senate.
The Florida call for Mr Trump changed everything, said the head of Treasury trading at one hedge fund. “The bond market responded very, very aggressively,” he said.
Having soared to 0.94 per cent, 10-year Treasury yields tumbled back below 0.8 per cent — one of the biggest post-election bond rallies since 2000 — as investors dialled down expectations for a big debt-financed stimulus package.
Stocks were steadier in thin trading, but futures took a hit when Mr Trump late on Tuesday night prematurely claimed victory and baselessly claimed the election was “a major fraud on our nation”, raising the possibility of a messy transfer of power, one of Wall Street’s worst-case scenarios.
Still, battle-hardened traders and investors, who dealt with chaotic scenes in markets in March all while working from home, took it in their stride. Trading volumes in most asset classes peaked around the time that Mr Trump won in Florida, and tailed off by dawn.
It became clearer that Mr Biden’s strength in mail-in ballots might still tip the scales in his favour, boosting expectations for a split between the White House and Senate.
“This is not the worst outcome from the market’s perspective,” said Sonal Desai, chief investment officer at Franklin Templeton’s fixed income group. “For some of the less market-friendly policy measures which had been espoused by the Democratic platform, there will at least be some restraint, and that will come from the Senate.”
The S&P 500 rose 2.2 per cent, its best one-day gain since June, with technology stocks dominating once again.
The stocks rally continued and broadened, despite president Trump fulminating against the swing towards his rival, and Republicans launching lawsuits to halt the count of mail-in ballots in states where the incumbent was leading.
However, many investors also took heart from the lack of severe unrest. As a result, the Vix volatility index sloped down on Thursday to its lowest level in a month
“Downside risks remain in a contested election outcome, but the key drivers for risk assets are still in place in our view,” said Mark Haefele, chief investment officer of UBS Global Wealth Management.
By the end of the week, victory for Joe Biden looked increasingly likely after he took the lead in Pennsylvania, but the stocks rally cooled.
After gaining more than 7 per cent through the first four days of the week, the S&P 500 was flat on Friday, while the yield of the 10-year Treasury nudged back to 0.83 per cent.
The potential for a split between the presidency and Congress, which is still not assured, also weighed on the dollar. With a fiscal boost now likely to be later, and smaller, than it might have been under clear Democratic control, the US Federal Reserve is more likely to have to step up and provide dollar-denting monetary stimulus.
The dollar index, which tracks its value against a basket of peers, has fallen by the most this week since March. “More Fed easing is on the way,” said Salman Ahmed, global head of macro at Fidelity International.
Yet some analysts warned that markets may be underestimating the danger that president Trump’s final months in office could be turbulent.
“If you have a result that is very close and one of the candidates is unhappy and they ask for a recount, there is a legal and well-trodden path if they want to clarify [the outcome],” said Francesca Fornasari, head of currency solutions at Insight Investment. “If it becomes more long-lasting and adversarial and goes through the courts in what is not necessarily a well-trodden path, I suspect that will have more long-term repercussions.”