By Matt Scuffham
NEW YORK (Reuters) - Global banks are preparing for the possibility that there will be no clear victor on the night of the U.S. presidential election, a scenario that could spark days or weeks of chaos in global equities and fixed income markets, several bankers said.
Over the past two weeks, major banks have run simulations to ensure they could cope with a spike in market, liquidity and credit risks, and have been advising clients on precautionary hedges and capital raising strategies if a contested election result on Nov. 3 leads funding markets to dry up.
Reuters/Ipsos polls show the contest tightening, with Democratic candidate Joe Biden holding a slim lead over President Donald Trump in three highly competitive states, while three other battlegrounds show a dead heat. A surge in postal ballots driven by pandemic fears is expected to delay some results.
"We're starting to talk not just to clients, but also to our staff, about the potential that you might see a longer than expected period (with no clear result) because of the large number of mail-in votes," said Itay Tuchman, Citigroup (NYSE:C)'s global head of FX. "We're getting prepared for that."
If the winner is too close to call, a legal battle and even a constitutional crisis could ensue, say bank strategists. Trump last week said he expects the result to be settled by the Supreme Court. Tuesday's unruly first televised presidential debate has added to the uncertainty.
"If there is a constitutional crisis, we believe that the loss of political credibility and standing of the United States as a stable country could threaten its status as a safe haven with unfathomable consequences for the economy and for markets," BNP Paribas (OTC:BNPQY)' Head of Macro Strategy Daniel Ahn said.
JPMorgan (NYSE:JPM) and Goldman Sachs (NYSE:GS) also flagged the risk of a contested result in research published this month.
TESTING OUT SCENARIOS
One person at a major Wall Street bank said over the past two weeks his institution had been running models to stress test market, credit and liquidity risks in the worst-case scenarios.
Market participants need to ensure they have enough funds set aside to take advantage of the volatility and not be over-exposed to any single asset, said Matt Freund, head of fixed income strategies at global fund manager Calamos Investments.
"You have to make sure that you're not in a position to be a forced seller and you need to make sure that your liquidity is adequate so that you can view volatility as an opportunity and not a problem," he added.
Trading desks were caught off guard twice in 2016 when Britain voted to leave the European Union and when Trump defeated Hillary Clinton. At one point on the night of the British referendum, JP Morgan processed around 1,000 trades per second on its electronic FX platform, the bank has said.
The 2020 election will once again put traders through their paces, with U.S. futures markets pricing in twice as much volatility in the next two months as in the period before and after the 2016 U.S. election. But banks are wiser this time, while the pandemic has also helped many prepare technology and staff for extended periods of turmoil, even with staff working remotely.
Volatility could also prove a boon for well-positioned Wall Street banks, some of which have already had their best trading year in a decade by helping clients shuffle their portfolios around amid this year's upheaval.
Some bankers said they are discussing with clients strategies for navigating volatility in both the run-up and aftermath of Nov. 3. One senior executive at a big European bank with U.S. operations said he was advising clients on hedging strategies that could offer protection across rates, currencies, commodities and equities markets.
Wary the capital raising window will slam shut, others are also trying to expedite deals.
One senior capital markets banker said the biggest worry was that a contested election would see debt markets dry up. They are telling clients not to wait: "If you know you are going to raise capital this year, then you should go sooner rather than later whilst we can still predict the short-term."