USD edges stronger as Obama elected next US president. How much longer does the risk appetite honeymoon last?

Barack Obama swept to victory by a margin that was widely expected and the Democrats also made solid gains in the House of Representatives. As election day got underway yesterday, there was a real sense that the market was going into "risk reduction" mode, taking off its heaviest positions before the results started rolling in. The USD and JPY tanked, equities were up sharply, bonds were also up (some might consider this strange if the supposed theme was higher risk appetite, but the market is already very heavily positioned on the short side in fixed income, so yesterday's move was likely simply position-trimming). The USDJPY barometer was interesting to watch as it briefly shot higher in sympathy with equities and USDJPY was through the psychologically significant 100.00 level before diving for cover again - setting up yesterday's highs as a reasonable risk point for new attempts to short the pair. As the results began rolling in, the day's moves unwound further in FX, though equities remain close to their highest levels.

We have two scenarios for this rally in risk appetite we see here is unlikely to have significant legs. One scenario is that we move into a rangebound environment, with rallies in risk appetite capped, but downside volatility unable to work up a significant head of steam again as it did previously. This scenario would allow volatility to fall somewhat. The other possibility is that we go straight back to risk aversion mode. The scenario we don't look for is a for any continued heady rally in equities and JPY crosses, for example, beyond the next few days.

The very measured reaction to the news of the Obama victory suggests that this event risk was mostly priced in for the short term. In the bigger picture, of course, this event marks the starting point of a new era in market history and we will have plenty of time to think about the consequences of a new Democratic president with strong majorities in both house of Congress. This is a very different environment than the one under Clinton, for example, whose initiatives were hampered by Republican lawmakers for most of his presidency. With a population suffering and looking for change and one political party clearly in power, it is obvious that policy response will be a pivotal input in trading and investment opportunities for at least the next two years until the midterm elections of 2010.