How will the US election impact FX market?

The US election on Tuesday is the focal point, of course, but there’s also a Federal Reserve meeting two days later, and some other central banks will have important decisions to make as well, not least the Bank of England. It might be a time for traders and investors to sit on their hands as uncertainty and volatility could be off the chart. But what of those that want to be involved? What strategies should they employ?

The Standard Bank’s view is that former president Trump will win the election while both the Fed and the BoE cut rates 25-bps. But we will also explore strategies should events turn out differently. If we start with cash rates, we expect that a victory for Trump will not deter a Fed rate cut this week but will see the market price out some of the easing that’s in the curve right now, and this move will probably be larger if the Republicans get to control both the House and Senate after the election. The market is currently priced for close to five 25-bps cuts by the Fed through to the end of 2025 but the Standard Bank thinks this will be trimmed to four, if not three, should Trump win. Hence, a short position in longer-dated SOFR futures is one way to play the ‘Trump trade’.

However, what if Harris wins? Will things go the other way? They might, but the Standard Bank suspects any rally in longer-dated SOFR futures would be much smaller in size than the decline we’d see under a Trump victory. Another point, however, is that this may well prove a temporary reaction should Trump win, as we’d look for more rate cuts to be priced back into the curve again once the initial reaction to the victory has played out.

What about cash rates and implied easing expectations in other countries? If a Trump win prices out some Fed rate cuts from the curve, will other countries see the same dynamic with fewer rate cuts priced into their curves? Or will the fact that Trump’s policies are likely to damage other economies, notably from higher tariffs, make central banks more, not less, likely to cut rates; something that the market could start to price in? In short, should traders be prepared for longer-dated euribor futures in the euro zone, or Sonia futures in the UK to fall or rise if Trump wins? “We think futures prices will fall initially, but any such decline could represent a good medium-term buying opportunity as we do not think that policy easing by the likes of the ECB or BoE over the coming year will be compromised by a Trump win, even if that’s how the market initially reacts”, said the Standard Bank.

What about the FX market? The Standard Bank expects a Trump victory to lead to a short-term rally in the US dollar. In theory, the currency to focus on is the Chinese renminbi for it is here that Trump is proposing tariffs of 60%. Just whether he is likely to deliver on that is a matter for debate, but we do not think there’s much debate that the Renminbi will be in the firing line. While short renminbi positions might be preferred, we also have to accept that the PBoC, through the state banks, will likely resist any significant renminbi weakness and this might mean that it is better to focus on renminbi ‘substitutes’ instead. Namely currencies of countries that trade heavily with China but where FX movement is not impeded by government influence.

One of these could be the yen, although the Standard Bank suspects that the most vulnerable G10 currency would be the Australian dollar and hence short positions here, either against the US dollar, or on a cross basis seem wise. Of course, a Harris win would allow the likes of the aussie to escape but there is another point here which is that if Harris wins very narrowly, and we see a scenario of social upheaval in the US, spurred on by accusations of a second ‘stolen’ election by Trump, then this could weigh heavily on risk assets, and risk currencies, such as the aussie. So, while the US dollar may be desirable on a Trump win, there’s also a case for holding ‘safe’ currencies such as the yen and Swiss franc on a cross basis as a sort of hedge should Harris come out as the victor on Tuesday.