June 22, 2018 / 4:35 PM / 6 months ago

GRAPHIC-Election fever seen ramping up emerging mkt FX volatility

LONDON, June 21 (Reuters) - Turkey kicks off a four-month run of crucial emerging market elections this weekend that are expected to cause some of the most extreme moves in the voting countries’ currencies in years.

As well as Turkey on Sunday where the question is how much power Tayyip Erdogan and his AK Party get, Mexico looks set to vote in a new leftist president the week after, while Brazil’s election in October is wide open.

All three carry uncertainty, big uncertainty according to the options volatility markets that traders and investors use to put bets on or take out insurance against major currency swings.

As the chart below shows, ‘implied volatility’ for Turkey’s lira both over Sunday’s elections and a potential July 8 second round Presidential vote have surged to the highest levels since the financial crisis.

For Mexico’s peso around its July 1 election it is the highest since Donald Trump’s 2016 U.S. election win, while levels for Brazil’s real in October are as high as they were during last year’s presidential corruption scandal.

“These markets are pricing close to a four percent move in spot lira (around the election) and you would expect that to happen in Mexico and Brazil too,” said UniCredit emerging market strategist Kiran Kowshik.

“Political events will really affect asset prices if you think a change in government, or whatever happens, can affect macroeconomic policy.”

That key element of change exists in all three of the upcoming elections.

An Erdogan victory in Turkey accompanied by strong support for his AK Party would be interpreted by some investors as a source of political stability.

AKP could actually lose its parliamentary majority though, and there’s a chance Erdogan won’t even remain president which could also be welcomed if it steers the country back towards a more open political environment.

In Mexico, traders that have battled through the peso’s woes could lose their nerve if Andres Manuel Lopez Obrador wins the presidency and gains a congressional majority that would give him a freer hand to make radical changes.

“We hope that we don’t hear huge amounts of un-market-friendly comments after the election,” said Andrew Stanners, an emerging markets bond fund manager at Aberdeen Asset Management in London.

WILD RIDE

Almost half the countries in terms of weighting on the world’s big bond indexes will hold elections this year but these are seen as the big three.

In Brazil, far-right candidate Jair Bolsonaro has emerged as the frontrunner in the absense of jailed leftist ex-president Luiz Inacio Lula da Silva.

A former army captain, Bolsonaro he says he would include generals in his cabinet if he wins and allow police to shoot criminals dead if they are fired at. Investors crave reforms that would start repairing the country’s battered finances.

Extreme moves in implied volatility markets don’t always translate into spot FX moves, but they do tend to be a good indicator if a currency is set for a wild ride.

Turkey’s lira fell almost 30 percent back in 2008 when implied vol levels were reaching their peaks and then rallied 15 percent in just over a month when they started to come back down.

The currency has already slumped 20 percent this year but has performed broadly in line with other emerging market currencies since the central bank jacked up interest rates.

Implied volatility levels that go beyond the elections show a notable drop off. There are more regional votes next year though and the stormy conditions buffeting all emerging markets at the moment mean volatility looks set to stay generally elevated.

In this environment knife-edge elections are a combustible ingredient.

“If the market is expecting an election outcome and if it doesn’t happen, in this market, it can cause a lot of volatility.” said Abhishek Kumar lead EM portfolio manager at State Street Global Investors.

Reporting by Marc Jones Editing by Peter Graff

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