Global Investors Turn to U.S. Dollar as Key Events Loom

By Harry Robertson and Naomi Rovnick

LONDON (Reuters) – Investors globally are piling into the U.S. dollar and betting on rising volatility ahead of crucial upcoming events, including elections in the United States and Japan, interest rate decisions from three major central banks, and the new UK government's budget presentation.

The U.S. currency hit a three-month high this week, fueled by a strong U.S. economy and the potential for former Republican president Donald Trump to win the Nov. 5 elections.

Options markets indicate that investors expect increased currency and bond volatility in the coming month. Despite this, stocks remain relatively calm amid strong U.S. economic data, although the VIX index indicating expected equity market swings is above its 2024 average, hinting at potential turbulence ahead.

Ales Koutny, head of international rates at Vanguard, remarked, "We're going to have quite an incredible, volatile two weeks," noting his shift to cash by selling some assets.

TRUMP TRADES

Trump is in a close race with Democrat Vice President Kamala Harris, but betting markets suggest Trump's odds are improving. The dollar has risen more than 3% in October, partly due to bond yields climbing toward three-month highs, fueled by concerns over potential tariffs under a Trump administration that could increase inflation and keep the Federal Reserve's rates high.

Concerns over trade have pushed the expected volatility in euros to its highest in 18 months. James Athey from Marlborough expressed a defensive shift in his portfolio, anticipating further dollar gains and reducing exposure to U.S. government debt in favor of German bonds.

Meanwhile, investors wary of inflation and populism are increasing their gold investments, according to Bank of America, while Citi data indicates hedge funds are favoring the dollar. The International Monetary Fund warned that markets might be underestimating geopolitical risks ahead of the elections.

US JUGGERNAUT

The primary driver for the dollar's strength is the continuous U.S. economic growth, with strong jobs reports, retail sales numbers, and low jobless claims leading investors to reconsider Federal Reserve rate cut bets. The jobs data for October, due on Nov. 1, could heavily influence the Fed's decisions, with expectations now leaning toward a 25-basis-point cut after prior predictions of a larger cut.

Bond yields continuously fluctuate as traders assess the Fed's stance, pushing expected volatility in the $27 trillion Treasury market to 10-month highs. The CBOE Skew index, which measures the demand for options that pay out during significant stock declines, indicates rising anxiety among investors.

While stocks have remained stable, the S&P 500 index dropped slightly by 0.9% this week. Positive earnings from companies like Tesla, combined with robust economic data, have contributed to the equity market's calm. Artemis' Liam O'Donnell has recently purchased five-year Treasuries, believing that markets might be overestimating how high U.S. rates could remain under a Trump presidency.

POLLS, POLICY

In Britain, the Labour government will present its first budget following their power win in July, ahead of the Bank of England's interest rate decision on Nov. 7. Past memories of the 2022 bond market chaos, triggered by Prime Minister Liz Truss’s failed budget, linger.

British government bond yields rose sharply after finance minister Rachel Reeves announced changes to fiscal rules allowing for more investment borrowing. Investment firms like Allianz Global Investors and PIMCO anticipate gilt yields to have surged too high.

Linda Raggi, from Pictet Asset Management, said, "We have recently initiated a long duration position in gilts. We believe the budget will focus on supporting growth and think gilts have room to outperform once the event risk passes."

Japan's political situation and central bank actions are also pivotal, with a recent rate hike and yen surge causing global market volatility in August. The ruling Liberal Democratic Party in Japan may lose its majority in the upcoming snap election, possibly forming a coalition with opposition parties favoring monetary stimulus. Traders expect the Bank of Japan to maintain steady rates on Oct. 31, observing for outlook indications that could affect the yen, which has fallen over 8% since mid-September.