US Election Risks Are Starting to Show Up in Foreign Exchange Markets

(Bloomberg) -- Currency markets have started pricing in elevated foreign exchange volatility around the US vote on Nov. 5, even with election day almost six months away.

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That concern is particularly pronounced in options betting on the Chinese offshore yuan, with the spread between six- and three-month implied volatility for the currency soaring for a second day. The spread rose to 1.20 percentage point on Tuesday, up from 0.73 percentage point on Friday, the biggest increase since 2011 when that information first became available, according to data compiled by Bloomberg.

Traders appear to have factored in a binary scenario, with a win by Donald Trump likely leading to a surge in volatility and a major selloff in the offshore yuan. That setup is reminiscent of 2016, when Trump was first running for president.

Back then, the Mexican peso served as a bellwether for currency-market sentiment and Trump’s victory caused volatility to soar toward crisis levels. This time, the Chinese yuan is likely to take that role, leaving options traders on the edge.

With six-month volatility now covering election day and three-month volatility expiring in August, the difference between the two metrics underscores the amount of investor concern about the vote and its potential impact on currency swings. For the Chinese yuan, political risks appear elevated based on options pricing, likely a result of past inferences by Trump that he might impose 60% tariffs on imports from China.

“A 60% tariff as pledged by Mr. Trump would be prohibitive — in theory it could squeeze all Chinese products out of US markets,” said Xiangrong Yu, chief China economist at Citigroup Inc.’s global markets group. “The RMB exchange rate could show some knee-jerk reactions and move toward 7.7-8.3 in this full decoupling scenario,” Yu wrote in a research report last month, referring to the Chinese yuan.

Jitters are also showing elsewhere, though they aren’t as pronounced. The spread between six- and three-month implied volatility for the Mexican peso stood at 1 percentage point on Tuesday, up almost fourfold from Friday’s close yet still below its 2024 high. For the euro, the gap between six- and three-month volatility approached 0.5 percentage point on Tuesday, a level last seen in November 2021, the data show.

Trump has floated the idea of a 10% levy on all foreign imports, with European Central Bank President Christine Lagarde warning earlier this year that the continent should prepare for “potential tariffs” and “harsh decisions” ahead.

Potential trade conflicts as well as tariffs continue to present major risks, according to Meera Chandan, JPMorgan & Chase Co.’s co-head of global FX strategy. “We have been recommending tactically reducing dollar longs in the past week, but still maintain long USD exposure via options,” Chandan said.

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