What will drive the US dollar in the short term?

>> How will the US dollar move if Trump wins again?

It remains to be seen whether US President Joe Biden’s decision not to seek a second term enlivens the rather comatose dollar. It will not; at least not for now. His decision changes the November 5th election dynamic from one that started to look like a Trump shoo-in to one that could be competitive again. Or, put another way, the FX market is being forced to move from a position of growing certainty (of a Trump win) to a situation of high uncertainty.

And, contrary to what you might read in the financial press, it is certainty that causes market volatility, not uncertainty. When things are uncertain, traders and investors don’t know what to do and, for that reason, often do nothing. But when certainty takes hold, it becomes obvious how the market should react and asset price movement can become impulsive and rapid. This is why we see the most volatility and directional movement in currencies when certainty follows uncertainty.

For instance, financial markets were uncertain whether Russia would attack Ukraine, and, in the three-months leading up to the attack, the US dollar barely moved with just a 2.5% range for the greenback’s trade-weighted index (DXY). But once this uncertainty had been replaced by the certainty of Russia’s assault in February 2022 the subsequent three months saw a rise of 6.7% and a trading range of over 9% as traders and investors quickly discounted the implications of Russia’s actions.

This being said, anticipating the impact of a war on currencies, or a pandemic, or many other events might be straightforward, but reaction to either a win for Trump or the Democratic nominee on November 5th could prove more difficult.

As a result, we are not tempted to project a significant directional move in the US dollar after November 5th. At this early stage, we think it is still likely that former President Trump will win a second term, with the most likely implication for the US dollar being a brief rally that fizzles out into longer-term weakness, much as we saw during his first term.

Another point we have to bear in mind is that the Fed was raising policy rates during the first two years of his presidency but, if Trump wins a second term, it will likely be against the backdrop of Fed easing, and we suspect that this will impart a weaker bias for the US dollar that could easily trump Trump, if you excuse the pun.

The most significant impact on the FX market from the presidential election could easily be outside the US rather than on the US dollar, particularly if Trump wins. For a start, there are pretty clear proposals for punitive tariffs on China of between 60% and 100% according to Trump, while other countries seem set to get off more lightly with tariffs of only 10%.

>> What’s best for a currency?

Should such action be taken, it could clearly weigh on the renminbi at a time when the currency is already being pressurised by its rate spread deficit to the US and the weakness of the economy. The surprise weekend rate cut from the PBoC was notable because the bank felt ready to ease policy before the Fed has started its own rate-cut campaign.

It might be betting that the Fed will start to cut rates soon, possibly from September, and that this will give the renminbi some breathing space but Steve Barrow, Head of Standard Bank G10 Strategy suspects that US tariffs under a Trump presidency could dominate and so pressurise the renminbi. The sense that tariff increases (by the US) would be offset by a stronger US dollar is pretty well established, but it appears that a second term for Trump could see the administration pursue a policy to try and counter any such currency strength.

Now it can’t do this with monetary policy, as that’s under the Fed’s control, but it does appear that the bank will be aiding any desire for dollar weakness by cutting rates unless, that is, the Fed decides that there’s a risk of higher inflation due to policies such as tariff increases and migration curbs. “Currency intervention is possible but was an unused tool during Trump’s first term despite his continual complaints that the US dollar was too strong. It is even stronger now and with the yen particularly weak it is not so hard to envisage a Trump-led Administration voicing vocal support for Japan’s plight, if not physical intervention. If we put these two issues together it could be that a long yen and short renminbi trade is the best way to play a second Trump term”, said Steve Barrow.