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CORRECTED-UPDATE 3-Vote and virus: volatile markets bring reminder of March turmoil

(Removes incorrect reference to three-month euro-dollar swaps hitting 150 bps in March, previously in paragraph 15)

LONDON, Oct 28 (Reuters) - Equity and currency volatility shot higher on Wednesday and the cost of sourcing dollars rose, reflecting fears that the U.S. election and resurgent COVID-19 pandemic could tip markets back into the sort of chaos endured earlier this year.

A selloff in March wiped a third off the value of U.S. stock indexes over a three-week period and the premium for cash dollars hit multi-year highs as the pandemic slammed markets and locked down economies.

Now, with less than a week to go before the U.S. presidential election, a resurgence of COVID-19 cases is forcing Germany and France to consider stringent new restrictions that will almost certainly damage Europe’s faltering economic recovery.

Ulrich Leuchtmann, head of FX and commodity research at Commerzbank said a double-whammy of the pandemic accelerating and an unclear election result could push volatility significantly higher.

“In the case of a very chaotic U.S. election outcome this might even come to or close to the level we saw in spring.”

Concerns were most strongly reflected in currency markets, especially in the implied volatility contracts derivatives traders use to protect investments against sudden swings in the exchange rate.

One-week euro and yen implied volatility against the dollar rose to their highest in nearly seven months , nearly doubling from a day ago as the maturities now encompass election day on Nov. 3 and the day after.

The euro also came under pressure in cash markets, weakening 0.6% versus the greenback, while U.S. and European stocks fell by 3% or more .

The election outcome has particularly strong resonance for China, which has endured higher trade tariffs and a hostile backdrop for its tech firms under U.S. President Donald Trump.

A win for Democrat challenger Joe Biden, who is currently ahead in opinion polls, would mean more predictable trade policies.

One-week offshore Chinese yuan volatility traded at 10.950, the highest since Jan. 7, 2016.

“We’ve got so much uncertainty ahead,” said a trader at a Chinese bank.

LIQUIDITY SQUEEZE?

While a Biden win is widely viewed as dollar-negative, dollar swap markets, where traders outside the United States source the currency, suggest some investors are starting to hedge their bets.

Three-month euro-dollar swaps rose to 18.5 basis points, close to a one-month high, reflecting investors’ willingness to pay a greater premium for dollars.

With central banks now providing ample liquidity support, reflected in money market funds and corporate balance sheets flush with cash, this week’s market jitters are not indicative of an impending dollar shortage.

But with economies under fresh pressure and European COVID deaths up 40% in the past week, investors are taking no chances and the VIX equity volatility gauge is already close to its June highs.

“Investors are finding a reason to sell,” said Chris Bailey, a strategist at Raymond James, noting the risk to growth and economic recovery from tricky U.S. stimulus negotiations, a surprise or disputed election outcome and renewed lockdown calls.

Reporting by Saikat Chatterjee, Elizabeth Howcroft, Richard Pace in LONDON, Andrew Galbraith and Winni Zhou in SHANGHAI; Editing by Sujata Rao, Kirsten Donovan

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