Biden exit leaves markets asking what's next for 'Trump Trade'

Investors are set to start the week scrambling to decide if President Joe Biden's decision to end his reelection campaign and endorse Vice President Kamala Harris increases or decreases Donald Trump's chances of regaining power. 

READ MORE: How would a second Trump presidency change the mortgage industry?

The earliest opportunity for traders to respond comes as trading in currency markets picks up in Asia's early Monday session. 

In the weeks since a disastrous debate ignited concerns over 81-year old Biden's ability to serve another term, financial markets downgraded his chances of success. They've generally favored trades seen benefiting from Republican Trump's advocacy of looser fiscal policy, higher trade tariffs and weaker regulations. 

READ MORE: MBA's Killmer on election stakes for mortgage players

That's taken the form of support for the dollar, rising U.S. bond yields and gains in bank, health and energy stocks as well as Bitcoin.

The question for investors is whether to stick with such trades now that Biden has dropped his bid for reelection. Markets may be jumpy as traders wait to see if Harris secures her party's nomination and weigh if she can then gather enough momentum to challenge Trump's lead in the polls. 

"Investors should expect a spike in volatility," Dave Mazza, chief executive officer of Roundhill Financial, said before Sunday's announcement. "If Vice President Harris can mobilize 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."

READ MORE: What will happen to credit risk transfers after November?

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.

A fresh Democratic ticket means "Trump trades would wobble as markets recalibrate the odds," Grace Fan, managing director of global policy research at GlobalData.TS Lombard, wrote in a July 17 note. Those wagers are "are unlikely to budge much," however, if Harris is the eventual candidate, she said. 

Bonds and Currencies

The dollar is generally expected to get a boost if another Trump presidency looks more likely. Trump's preferred mix of low taxes and high tariffs are seen as spurring inflation and interest rates, adding to the dollar's appeal. The currency also experiences higher demand in periods of uncertainty thanks to its haven status.

Potential losers in the face of a rising dollar include the Mexican peso and Chinese yuan.

Still, the dollar fell against the yuan and Japanese yen last week after Bloomberg Businessweek published a June interview with Trump in which he noted a strong greenback had hurt American competitiveness, a point also made in the past by his running mate, JD Vance.

READ MORE: Presidential debate skirts housing affordability

"We do not think this is the right trade," strategists from Barclays Plc said in a Sunday report. "A second Trump term would imply further dollar strength, in our view, and the recent dip provides good levels to re​-​engage with our recommended longs" such as the dollar against the yuan. 

The conclusion that Trump spells inflation has also seeped into the world's biggest bond market, with traders embracing a wager that involves buying shorter-maturity notes and selling longer-term ones — known as a steepener trade. 

"As Harris's odds have risen, so have the Democratic odds of winning the House," said Steven Englander, a strategist at Standard Chartered Bank in New York. "If this is how it plays out, then fears of further fiscal stimulus may wane and take some pressure off rates and the U.S. dollar. But it is still very early days on what may be a very different campaign than expected even two weeks ago."