US Republican presidential candidate Donald Trump (right) and his vice-presidential pick JD Vance.

(July 22): Investors have been amassing wagers on Donald Trump’s return to the White House for weeks, trimming holdings of long-term US bonds and buying bitcoin, among other things. Now, they are considering whether Joe Biden’s exit from the race boosts the odds of a Democrat victory — and how much they must recalibrate their bets.

One thing seems certain after the president dropped his re-election bid: Though the announcement was widely expected as the 81-year-old faced pressure from allies, it injects a wild card into the campaign that will likely translate into volatility for markets.

“This means more uncertainty,” said Gene Munster, a co-founder and managing partner of Deepwater Asset Management. “There was a lot of confidence about Trump winning, and markets won’t like this new uncertainty, along with the news cycle about who is in, who is out, and all those unknowns.”

Biden’s announcement on Sunday that he is ending his effort to seek another term and endorsing Vice President Kamala Harris is the latest of several political shocks absorbed by markets in recent weeks.

As investors digest the latest news, the Trump trade — favouring sectors and strategies seen as benefiting from the Republican’s advocacy of looser fiscal policy, higher trade tariffs and weaker regulations — is likely to face headwinds.

This, while investors are also bracing for potential market convulsions from the wave of second-quarter earnings results that are just starting to come through, and as they continue to plot scenarios for when the Federal Reserve (Fed) will begin cutting interest rates.

Investors react

The dollar edged lower in Asian trading on Monday, with the euro, Swiss franc and Mexican peso seeing marginal gains. Treasury yields dipped across the curve, while US equity futures were modestly higher.

“The main thought process in the bond market should be what this new uncertainty brings. People had gotten to the point where they were piling into the Trump trade — with it beginning to become a real narrative. I had thought that was way too soon,” said Glen Capelo, the managing director of Mischler Financial. “The curve steepening trade will probably have to unwind a little bit.”

Markets may be jumpy as traders wait to see if Harris secures her party’s nomination and gathers enough momentum to challenge Trump’s lead in the polls. As traders await new polls reflecting Biden’s absence, betting market PredictIt has Harris as the favourite to become the Democratic nominee, but Trump still favoured to win the presidency.

The basics of the Trump trade have taken the form of support for rising US bond yields, gains in bank, health and energy stocks as well as bitcoin and a stronger dollar — even as Trump himself has signalled he prefers the US currency to weaken.

Some of the Trump trade in the bond market had already started to subside last week, as investors turned their attention back towards economic data and the Fed. Meanwhile, recent moves in stocks have been marked by a shift out of Big Tech shares and into smaller companies in sectors that had been laggards.

“Investors should expect a spike in volatility,” Dave Mazza, the chief executive officer of Roundhill Financial, said before Sunday’s announcement. “If Vice President Harris can mobilise quickly to give Trump a material run, then we should expect volatility to linger. However, if Trump continues to pull ahead in the polls and investors view his win as inevitable, then the Trump trade will take over and volatility will decline.”

There is little historical data to use for a read on how markets will react. The most recent example of a sitting president not seeking a second term was Lyndon Johnson in 1968.

“We just don’t have a lot of precedence for a situation with a candidate who did not go through the normal primary process,” said Julie Biel, a portfolio manager and the chief market strategist of Kayne Anderson Rudnick. “So we are once again continuing our very long-term love affair with unprecedented times.”

Some investors in Asia, before Biden stepped out of the race, saw the Trump trade actually benefiting from his departure, which could lead to pressure on everything from broad Chinese stock benchmarks to shares in South Korean battery makers in the region.

Asian shares fell on Monday, with Taiwanese and South Korean shares underperforming, though analysts said the moves were largely down to negative sentiment towards the technology sector.

One complicating factor for bets on Asian currencies has been Trump’s criticism of the current weakness in the yen and the yuan, which could cap pressure even if his victory is expected to broadly strengthen the dollar. The yen was modestly stronger in afternoon trading in Tokyo.

“Biden dropping out of the elections adds new uncertainties to the market,” said Citigroup Inc’s Johanna Chua. “The market will reassess not only the distribution of the presidential race probabilities, but also the implications for the congressional race outcomes.”

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