As the world eagerly awaits the outcome of the US presidential election, the currency markets are bracing for a period of heightened volatility. In our latest analysis, we delve into the potential impact of the election on the foreign exchange landscape, exploring the dynamics that are shaping the current market sentiment and the strategies investors can employ to navigate the turbulent waters ahead.

Brace for Liquidity Challenges and Shifting Hedging Patterns

Liquidity Dry-Up and Deleveraging Risks

The binary nature of the US election outcome has the potential to trigger wider deleveraging across the currency market, leading to a liquidity dry-up in the days leading up to November 5th. This dynamic is already evident in the performance of the G10 currencies, where the more liquid and less Trump-exposed currencies, such as the USD, EUR, CHF, and GBP, are outperforming the less liquid and more protectionism-sensitive currencies, including the AUD, NZD, NOK, and SEK. This trend is likely to continue in the coming days as investors seek to mitigate their exposure to the potential market disruptions.

Shifting Hedging Patterns and the Yen's Outlier Role

The Japanese yen is playing a unique role in this scenario, as it is the developed currency with the greatest influence from domestic events. Speculative shorts on the JPY are rising further after the ruling coalition lost its parliamentary majority, and the focus is now on the level at which authorities will want to put a stop to the USD/JPY rally. The Minister of Finance may not have a specific line in the sand for the pair, but rather adopt a more opportunistic approach based on market moves, similar to the latest round of FX intervention that was initiated right after a JPY-positive market event. Risks of further JPY near-term selling remain elevated, particularly ahead of the Bank of Japan meeting on Thursday and the US election next week.

Macro Data and the Dollar's Trajectory

While the market's attention is firmly fixed on the US election, the release of September's JOLTS job openings data today could provide a distraction. The recent hawkish trend in the USD swap curve pricing can only be inverted with evidence of a softening jobs market, meaning a reversal of the August jump in job openings from 7.7 million to 8.0 million. The consensus is for the series to flatten at 8.0 million. Additionally, the Conference Board Consumer Confidence index for October and September's wholesale inventories data will also be closely watched.Failing to see a deterioration in the US macro story this week could pave the way for further dollar gains, driven by US election hedges and broad-based deleveraging. We maintain a dollar-positive bias and wouldn't be surprised to see the DXY close near 105.0 on Election Day.

Navigating the Volatility: Strategies for Investors

As the currency markets brace for a period of heightened volatility, investors must be prepared to adapt their strategies to the changing market conditions. Diversification, risk management, and a keen eye on market trends will be crucial in navigating the turbulent waters ahead. By staying informed, nimble, and disciplined, investors can position themselves to capitalize on the opportunities that may arise in the wake of the US election.