Dollar Hedging Costs Highest Since 2022 on Election Risk

(Bloomberg) -- The price to hedge against swings in the US dollar surged to the highest in nearly two years as traders prepare for the risk of big market moves after next week’s presidential election.

Most Read from Bloomberg

A measure of one-week implied volatility on the Bloomberg Dollar Spot Index rose on Wednesday to the highest since December 2022, when recession fears briefly raced through financial markets. That indicates traders are preparing for large swings in the currency against major peers like the euro, yen, Chinese yuan and Mexican peso, pushing up the cost of options that protect against such moves.

“The election is a binary event for FX markets and thus demand for election FX hedges has increased,” said Skylar Montgomery Koning, a currency strategist at Barclays Plc in New York. Emerging-market currencies including the peso, yuan and South Korean won “screen as the most sensitive to the US election.”

The dollar index has risen more than 3% so far in October, putting it on pace for its best month since September 2022, after bond yields rose sharply as the economy continued to show surprising strength. The Bloomberg greenback gauge retreated on Wednesday for the first session in four amid month-end trading, but remained near highest since July.

Derivatives traders are now bullish on the currency as expectations for aggressive Federal Reserve rate cuts are dialed back, promising to keep yields higher in the US than elsewhere. The election may contribute as well if a question about the outcome drives investors into safe havens or a victory by Donald Trump threatens to fan inflation pressures by ushering in tax cuts and large tariffs against major trading partners.

Tax cuts would pour more stimulus on the economy and worsen the deficit, which has made betting on higher yields a so-called Trump trade. At the same time, tariffs could cut US demand for overseas currencies by curbing imports, helping to prop up the dollar even more.

“We see some risk that the market is prematurely pricing not just a Trump win but a Trump sweep and aggressive implementation of his tariff policy,” Steve Englander, head of global G-10 FX research and North America macro strategy at Standard Chartered, wrote in a Wednesday note.

The implied volatility for major peers underlying the dollar index spiked higher Wednesday. Expected swings in the euro and pound over the next seven days are the highest since the March 2023 banking crisis. In contrast to developed markets, where such moves are expected to fade in the weeks after the vote, the peso and yuan are seen extending market gyrations well into the next month.

For the dollar, the market moves are “indicative of the US election uncertainty,” said Marc Chandler, chief market strategist at Bannockburn Global Forex LLC. “The dollar has reached levels not seen a in a few months, which may be helping to underpin FX volatility more generally.”

--With assistance from Vassilis Karamanis.

(Adds latest market prices, positioning chart.)

Most Read from Bloomberg Businessweek

©2024 Bloomberg L.P.