US Elections and the FX Market

What we know, what we don’t

Elections. That time where the electorate vote to choose who will hold office. And when it determines who will enter, remain or leave the halls of power in the world’s largest economy, the results are certainly noted. That makes November an important month not just politically but also for financial market participants given market moves in the US are usually felt globally, and more so when much around the world is settled, valued, and/or priced in or against its currency.

This isn’t about who’s leading in the polls today and how it could shift between now and election day (or even election night), nor the volatility that might be experienced prior to the event when a survey gives a candidate a surprising boost. When it comes to a typical fundamental event, how much something is priced in prior matters, and if the results are in line with expectations may serve to reinforce recent price action. But even in that circumstance, market makers withdrawing prior means it’s easier to see volatility rise, and more so when market participant expectations of where price will settle widen.

Policies and control

While further details of the candidates’ policies are expected to emerge, when it comes to Vice President Harris, many are working under the assumption that any gaps are viewed as similar to President Biden’s. And a victory for former President Trump makes it tempting to look at the financial market performance during his time in office, though that and the economic data would be a bit more difficult to absorb off surface value for 2020 onwards due to the pandemic.

There’s also the matter of a clean (red) sweep taking the White House and Congress vs. mixed rule (either a Trump or Harris Presidency but with a Democratic Senate and a Republican House), with bigger moves expected in the case of the former while more contained and seen as relatively status quo for the latter with a few key changes depending on who’s president.

Here, it’s about FX

In this article, we’re looking at the foreign exchange (FX) market. Had this been any another country and it would be about where the currency of that country would settle, the trader then going about factoring it into the pair(s) they are trading that includes said currency. But when it comes to US elections, it’s about where the dollar could go and how other currencies separately might be impacted by the policies that are expected to target their economies.

That means a shift in narrative from the previous ‘convergence’ of the Federal Reserve (Fed) in cutting rates after many other key central banks had been fashionably early in reducing theirs to seeing how those central banks might react to the side effects of changes on the fiscal front. That’s not to say concepts like convergence or divergence won’t return. If anything, the capacity for desynchronization is larger absent a global shock that forces all central banks to act in relative unison.

Impact of policies on FX

It’s here where things start to get more subjective. But let’s look at the key items and their respective potential effects.

In terms of trade, higher tariffs are expected under a Trump presidency. The general thought is that it’ll be inflationary raising the price of goods imported into the US, but if it squeezes foreign producers (who in many parts of the world are already struggling), then that could result in deflationary pressures and weakness in export-oriented economies. In terms of currencies, its seen as positive for the US dollar, and those that are in the crosshairs of the trade war (as seen prior to the start of the pandemic) dumping their products in other markets at lower prices in turn would see their currencies weaken. Tough tariff talk has been replaced with relatively silent but still stern action against China out of the Biden administration, and if Harris at the helm at least seen as more lenient and in favor of global trade less likely to keep the dollar as bid as it would be under Trump. And if there’s any further deterioration in Chinese and Eurozone data would mean more leeway for tariff threats (and action) to deal a more sizable blow.

On the domestic front, if Trump’s priorities and policies of less collection and less spending translate into growth would usually be a positive dollar story, but boosting US domestic production and competitiveness means he wouldn’t want it too strong (even after reducing the competitiveness of importers by raising tariffs). Tax hikes are expected under Harris and so too government spending, but if doesn’t translate into growth means USD gains might be capped.

Looking at it geopolitically, and if the issues in the hot spots aren’t resolved could help the dollar via its safe haven factor, while agreements wouldn’t always necessarily favor the greenback but hurt the currencies of countries negatively exposed. Generally, ‘solving’ the crisis would reduce tensions and remove the risk premium and so too the dollar’s relative haven appeal.

And then there’s the Fed. You’ll read and hear plenty talk about how they’ll have to keep rates higher (or reduce rates by a smaller amount) under Trump due to inflationary pressures from tariffs and immigration, but there’s the matter of whether they indeed experience above-target inflation and any pressure (public as was the case prior) on the central bank to keep rates low. Otherwise, higher rates under a Trump presidency seen as USD plus, and lower rates to help weaker growth under Harris a negative for the currency.

Putting most of it all together, and the net expectation is a relatively stronger dollar under Trump and a weaker one under Harris, but we’re missing the bond market story and the likelihood of a debt crisis, which if occurs would likely force the Fed to intervene, in the short term the severity of the event potentially positive for the greenback before restoring calm would likely cause it to undo any gains.

Historical moves

It’s always tempting to look at the chart and see what happened prior. And the irony is that even after the conclusion from all the above, historically, the US Dollar Index has fared better under Democratic presidents. But in terms of performance following the elections and the story is mixed, with the recent 2020 sending the greenback into contained retreat where the moves were eventually undone largely in the first quarter of the following year. The results in 2016 were a shock given what was initially predicted by the polls, with volatile moves that saw the dollar strengthen notably with an undoing taking an additional quarter. Re-election in 2012 saw simpler moves, while there were other issues to contend with in 2008 as the index plummeted in December but swiftly recovered thereafter.