US Election Sparks Yuan, Peso FX Volatility Surge

Key Takeaway

• FX markets show increased volatility bets around the US election, with a significant rise in the yuan's implied volatility spread.
• Traders anticipate major currency shifts, especially in the yuan and peso, based on election outcomes and potential Trump tariffs.
• JPMorgan advises reducing dollar long positions, highlighting ongoing concerns over trade tensions and tariffs.

Elevated FX Volatility Pre-US Vote

Currency markets are bracing for heightened volatility as the US election on November 5 draws closer, with a particular focus on the Chinese offshore yuan. The spread between six- and three-month implied volatility for the yuan has seen a significant jump, marking the largest increase since 2011. This surge in volatility is attributed to concerns over the potential impact of a Donald Trump victory, which could lead to a major selloff in the offshore yuan reminiscent of the 2016 election's effect on the Mexican peso. Traders are pricing in a binary outcome, with the possibility of Trump imposing 60% tariffs on imports from China, a move that could severely impact the Chinese economy and its currency.

Tariff Threats Stir Market Concerns

The prospect of Trump reintroducing tariffs has stirred considerable concern in the markets, with implications for the Chinese yuan and other currencies. Citigroup Inc.'s chief China economist, Xiangrong Yu, highlighted the potential for the yuan to weaken significantly in the event of full decoupling, driven by prohibitive tariffs. Similarly, the Mexican peso and the euro are experiencing increased volatility, reflecting broader market apprehensions about trade conflicts and potential tariffs. European Central Bank President Christine Lagarde has warned of the need for Europe to prepare for such eventualities, underscoring the global reach of these concerns.

USD Dominance and Asian Currency Pressure

The strength of the US dollar, fueled by a rally in US equities and the Federal Reserve's interest rate stance, is exerting pressure on Asian currencies, particularly the Japanese yen and the Chinese yuan. The yen's depreciation and the yuan's cautious positioning reflect the challenges posed by the USD's dominance. This situation is further complicated by Japan's central bank policies and the Federal Reserve's "higher for longer" sentiments, which leave these currencies in a precarious position. The mixed responses in Asian equity and bond markets, with fluctuations in indices and yields, highlight the regional disparities and the complex dynamics at play.

Street Views

• Xiangrong Yu, Citigroup Inc. (Bearish on the Chinese yuan):

  "A 60% tariff as pledged by Mr. Trump would be prohibitive — in theory it could squeeze all Chinese products out of US markets... The RMB exchange rate could show some knee-jerk reactions and move toward 7.7-8.3 in this full decoupling scenario."

• Meera Chandan, JPMorgan & Chase Co. (Neutral on USD exposure):

  "We have been recommending tactically reducing dollar longs in the past week, but still maintain long USD exposure via options."