The U.S. presidential election is nine weeks away, but Wall Street has already chosen a winner: itself.
Just when you’d expect volatility to be on the rise in the face of mounting political uncertainty, the sanguine state of stock, bond and currency markets in the run-up to Nov. 8 paints a very different picture. On the surface, fear is nowhere to be seen. In its place -- optimism that four more years of political gridlock will stymie efforts to loosen the fiscal purse strings, forcing central bankers to continue relying on the same easy-money policies that have driven asset values to unprecedented highs.
A Hillary Clinton victory over Donald Trump combined with a split Congress would do just that, and it’s this Goldilocks scenario that Wall Street is pricing in, according to Bank of America Corp.’s David Woo. Yet that’s left hedge funds and other speculative investors exposed if the policy paralysis that’s dominated U.S. politics for the last six years doesn’t materialize again.
“Whatever the probability you may give to it now, a clean sweep with the same party winning the presidency and control of Congress would have a massive impact on markets,” said Woo, head of global rates and foreign-exchange research at the Charlotte, North Carolina-based bank. "With the volatility market basically dead now, we are especially vulnerable to a risk-unwind scenario.”
At this stage of the race for the White House and control of Congress, investors are usually dialing down risk and loading up on insurance to protect against the unforeseen. Not this time.
Net long positions in contracts linked to the S&P 500 Index, Nasdaq 100 Index and Dow Jones Industrial Average climbed to $57 billion last month, the most since 1986, according to data compiled by Sundial Capital Research Inc.
Wagers against the CBOE Volatility Index reached a record last week, Commodity Futures Trading Commission data show. The options-derived equity fear gauge has plummeted more than 50 percent since reaching a four-month high in June.
“There’s something in the political calculus that’s missing in the models right now,” said Alan Gayle, a senior strategist at RidgeWorth Investments in Atlanta, which has about $37 billion in assets. “The low level of volatility suggests that there’s some hope gridlock will be maintained in November. But hope is not a strategy, and that complacency is vulnerable to a fairly significant shift over the next several months.”
Bond traders are just as confident. The CBOE/CBOT Treasury volatility index tumbled to 4.65 Tuesday, its lowest this year. The gauge, which measures the expected fluctuations in the 10-year Treasury note, has plunged since peaking in February, when investors fled to haven assets amid global financial-market tumult.
In the $5.1 trillion-a-day global foreign-exchange market, expectations for price swings over the next three months have also tumbled to near the lowest since December. And implied volatility on three-month options for the euro versus the dollar, the world’s most actively traded currency pair, has slid to 8.2 percent, down from 13.1 percent on June 24.