U.S. Vote: Pound-Dollar Poised for Gains on 'Blue Wave' Result, but Beware Protracted Uncertainty Short-term

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• GBP/USD spot rate at time of publication: 1.2938
• Bank transfer rate (indicative guide): 1.2577-1.2668
• FX specialist providers (indicative guide): 1.2819-1.2830
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How the U.S. Dollar trades for the remainder of 2020, and indeed over coming years, rests on the outcome of the U.S. election that gets underway today as whoever wins the White House will ultimately determine the direction of both fiscal and monetary policy over coming years and therefore the Dollar's long-term trend.

However, near-term fireworks cannot be discounted amidst concerns that the result of the vote could take days, or even weeks, to become known, creating ample conditions for a strong rally in the Dollar.

A record of more than 94 million voters have already cast their vote, either through early in-person voting in their states or by postal vote, which means many U.S. states may not be in a position to declare their results on election night.

It might therefore be days, or weeks, before the winner is declared as was the case in 2000 when the Supreme Court was asked to intervene.

"Market volatility could increase depending on the results and timing of the outcome of the U.S. elections on Tuesday," says Nikolaos Sgouropoulos, a foreign exchange strategist at Barclays.

Ahead of the vote the Pound-to-Dollar exchange rate is trading at 1.2932 which puts it back towards the centre of a September-November range:

Above: GBP/USD daily chart. If you are looking for a higher GBP/USD exchange rate be sure to contact your FX provider and set a limit order to automatically capture any gains. This is useful if the market is volatile. Find out more.

Foreign exchange analysts are almost unanimous in holding a view that a contested and protracted outcome would lead to short-term market volatility and Dollar strength. The Dollar remains a favoured safe haven asset that tends to benefit in such scenarios, therefore further losses in the Pound-to-Dollar exchange rate cannot be discounted.

However, any early indication that the polls are right and that Joe Biden has taken a commanding lead would likely to be negative for the Dollar as uncertainty over the result dissipates.

"National polls and prediction markets suggest that former Vice President Biden’s lead and the probability of Democratic sweep have declined in recent days but that a Biden victory and Democrat control of both chambers of Congress remain the most likely scenario," says Sgouropoulos. "As an initial market reaction, we would expect risk assets to rally in the case of a 'blue wave,' with EUR-satellites and high-beta and China-related EMFX stronger against safe havens such as USD and JPY."

A 'blue wave' scenario is where Biden wins the White House and the Democrats take the Senate, paving the way for a significant spending boost in early 2021. Investors see this as supportive of stock markets as the spending would likely support the economy until the coronavirus pandemic ends.

Under a sizeable fiscal expansion, combined with easy monetary settings at the Fed, the Dollar is tipped by foreign exchange analysts to fall.

"Markets seem to be looking for the Blue wave scenario, which should translate into weaker USD due the mix of expectations for larger US fiscal stimulus (which would benefit cyclical FX), the subsequent confirmation of low real USD rates for longer (as the Fed would stay behind the curve) as well as the anticipated return to the rules-based system for international relations, thus less benefiting the safe have dollar," says Chris Turner, Head of Research for UK & CEE at ING Bank N.V.

"All this should be positive for risk assets and higher beta G10 currencies but weigh on the Dollar," adds Turner.

Analysts at Lombard Odier - the private Swiss bank - have told clients they maintain the view of further Dollar downside for multiple reasons, with the expected outcome of the vote being one.

"The US dollar has by now given back most of its gains from September’s "mini" USD rally. This reflects still-weak momentum dynamics, fundamental dollar headwinds, and low market appetite for chasing the greenback higher," says Vasileios Gkionakis, Global Head of FX Strategy at Lombard Odier.

Lombard Odier cite the following for their Dollar view:

1) the Federal Reserve’s ultra-accommodative long-term stance
2) negative US real yields
3) a still-material dollar overvaluation
4) A base scenario of a Democratic sweep in the US elections.

"This last factor would likely lead the market to price in the reversal of the corporate rate tax cut," says Gkionakis.

Lombard Odier are forecasting the Pound-to-Dollar exchange rate to be at 1.35 by March 2021, ahead of a rise to 1.37 towards mid-year 2021.

"If the polls prove more accurate on this occasion, the election outcome could help to dampen the US dollar’s recent upward momentum. We continue to believe that the worst outcome for the US dollar would be if there was a Blue Wave and the Democrats took control of the Senate. Expectations for larger fiscal stimulus and improving global trade relations would support risk assets and help weaken the US dollar. However, if there is a surprise and the Democrats fail to take control of the Senate and/or Donald Trump remains President, it could reinforce US dollar strength," says Lee Hardman, Currency Analyst at MUFG.

The blue wave outcome requires the Republicans to take control of the Senate with a swing of four seats, political commentators say this outcome is likely to be less assured.

According to modelling by FiveThirtyEight, the Democrats have a 75% chance of flipping the Senate, which is down from the near-80% chance seen earlier in October.

"A ton of seats are still competitive; in 80 percent of our model’s simulations, Democrats wind up with anywhere between 48 and 55 seats. That’s a big range!" says Nathaniel Rakich at FiveThirtyEight.

Should the Republicans retain the senate but Biden wins the White House markets will digest the prospects of a less-generous fiscal support package, which could limit the downside damage to the U.S. Dollar.