Investors have been betting that next week's U.S. presidential election will trigger big swings in stocks, bonds and foreign exchange markets.

The Ice BofA Move Index, a key gauge of future direction for the U.S. Treasury market, has risen nearly 40% in October and hit its highest level in more than a year earlier this week.

"The most realistic risk in the near term is the election outcome," said Steven Oh, head of global credit and fixed income at PineBridge Investments.

Benchmarks measuring potential volatility in foreign exchange and stock markets over the next 30 days also rose ahead of Tuesday's vote as polls show a tight race between Republican candidate Donald Trump and Democrat Harris.

Investors said the close race had a bigger impact on markets than the potential for escalating conflict in the Middle East or concerns about the pace of Federal Reserve rate cuts.

“For us, this election is really important ... and more so than what the Fed or the economic data is telling you right now,” said Andrzej Skiba, head of U.S. fixed income at RBC GAM Bluebay.

Treasuries have sold off sharply in recent weeks as investors judged that a Republican victory was increasingly likely to lead to inflationary policies. The Move index, which reflects market expectations for volatility in Treasuries, rose, suggesting that investors expect further volatility ahead.

On the other side of the election, “you’re probably going to see a big re-rating of bonds,” said Emily Roland, co-chief investment strategist at John Hancock Investment Management.

“Once the noise clears, bond investors will be able to focus more on disinflationary trends,” which should push yields back down, she said. Yields move in the opposite direction to bond prices. However, she added that outcomes such as a Republican sweep of the White House and both chambers of Congress could push yields higher.

Wall Street's most prominent volatility gauge, the VIX, remained relatively calm overall, but climbed above 23 on Thursday as U.S. technology stocks led the stock market sell-off.

The VIX, which reflects the implied volatility of the S&P 500 over the next 30 days, has been below its long-term average of 20 for most of the past three months.

However, analysts say the index has been unusually high relative to realized volatility — the actual moves that occur in the stock market — in recent months, even before Thursday’s rally.

Binky Chadha, chief global strategist at Deutsche Bank, said the VIX index "doesn't look high, but if you compare it to realized volatility, it's very high... Implied volatility tells you that the market thinks there's a lot of risk."

Typically, the VIX trades a few points above a lagging index of realized volatility, but the gap between the two has widened dramatically recently. As of Wednesday's close, the VIX was nearly 12 points above realized volatility, approaching its largest gap since a brief spike in August amid a stock market sell-off.

Expected volatility in foreign exchange markets has also surged as traders debate the potential impact of policy proposals such as sweeping tariffs on U.S. imports. The Chicago Mercantile Exchange's (CME) implied volatility index for a basket of developed market currencies hit its highest level since early 2023 this week, while its Mexican peso volatility index surged to its highest level since Trump's first presidency.

Steve Englander, head of G10 FX research at Standard Chartered, told clients on Wednesday that volatility in foreign exchange markets has been more extreme than in recent election cycles, reflecting "uncertainty about the outcome of the election, uncertainty about Trump's policy agenda if he wins, and uncertainty about whether the outcome will be a Republican sweep or a split Congress."

Historically, implied volatility tends to rise ahead of presidential elections and dissipate quickly afterward, and many analysts and investors expect that to repeat.

Englander said currency moves could start to reverse “as the election results are extrapolated.” John McClain, portfolio manager at Brandywine Global, said: “Markets hate uncertainty, but once there is certainty, markets move on.”

However, with polls showing the election at a critical juncture, some are warning that volatility could linger longer than usual, especially if the outcome is challenged.

Pinebridge’s Oh said there was a chance of “a very, very close, contested election that leads to results that will be challenged for a long time” and that “it’s not a foregone conclusion to rule out the possibility of violence, even though it’s something we would like to avoid.”

Article forwarded from: Jinshi Data