Currency market calm could be shattered by the US election
For while one outcome – a win for incumbent Biden – may keep the US dollar subdued, the other outcome, of a victory for former president Trump, threatens to upend any stability.
>> How willl the UK and US elections impact currencies?
The degree of difference between the two outcomes makes life very hard for those that have future payments or receivables in US dollars beyond the election. It may mean that firms and individuals will have to act fast once the election results are known. The heightened volatility we’d expect to see on a Trump victory does not just reflect any immediate post-election shock value, but a longer-term lift in volatility compared to what’s likely to happen if Biden were to win a second term.
Steve Barrow, Head of Standard Bank G10 Strategy, said a Trump win would potentially create similarities with the election of Ronald Reagan in 1980. For over his two-term presidency, the US dollar initially rose by around 75% against the old German deutschemark only to give all this back, and more, by the time Reagan left office. Needless to say, it was a period of huge volatility; far more than anything we’ve seen during subsequent presidencies.
“Now, don’t get us wrong, we are not saying now that a second term for Trump could lift and then lower the US dollar by 75% against the euro. But what we do see is that many of the elements that were present during Reagan’s time in office are present again”, said Steve Barrow.
For a start, the fiscal/monetary policy mix is currently one of relatively loose fiscal and tight monetary policy and that’s the same as we saw under Reagan via the Economic Recovery Tax Act of 1981 which lowered personal taxation considerably. It is a combination that might keep interest rates relatively high and so suck in foreign capital, lifting the US dollar as it did in the early Reagan years, but it also risks excessive debt and US dollar overvaluation.
During Reagan’s term the extent of the overvaluation was deemed excessive and the US joined with other major nations to intervene to bring the US dollar down. This being said, the US dollar had already started to fall before the intervention and many analysts’ sense from that time was that the US dollar was destined to fall anyway.
The fact that the same countries had to intervene just a few years later to prevent an excessive fall in the US dollar rather suggests that the loose fiscal/tight monetary combination can only lift the US dollar for so long before budget and current account deficit concerns bring it back down to earth.
>> How will Greenback move before US presidential election?
“If we fast-forward to today there is already talk amongst Trump advisors that similar action might be needed again to weaken the dollar. Now we rather suspect that this won’t be the policy on the entry into office, but if a second term for Trump sees the dollar push significantly higher for the first year, or two, we would not be surprised to see Treasury action to bring it down, whether that’s supported by other G7 countries or not. Of course, it is possible that the loose fiscal/tight monetary policy combination unwinds. The Fed looks set to ease policy and Congress just might enact some meaningful deficit reduction. Either could prevent a significant US dollar advance” emphasized Steve Barrow.
However, Trump wants to add fuel to the inflationary risks it would seem by extending personal tax cuts and the Fed’s response to this could easily be to hike rates, even if it cuts them first before Trump takes office. We could reference other similarities between today and the 1980s by pointing to geopolitical tensions, which were elevated in the early 1980s by the US’s cold war with Russia, and could be elevated again by Trump; this time with respect to China rather than Russia via the introduction of really punitive tariffs on Chinese imports.
While undoubted similarities exist between the Reagan era of the 1980s and the prospect of a second term for Donald Trump next year we always have to be cognisant of the fact that nothing is ever exactly the same. As we mentioned earlier, the currency market was a pretty wild place in the 1980s and it has calmed down a lot since then. This is why any idea of 75% - plus rallies or falls in the US dollar seem very unlikely, even over a multi-year period. But directionally, the 1980s could offer the best clue we have about how the US dollar might trade if Trump wins a second term.