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US election and the potential impact for the currency market



Forward

With less than a week before the US Election, and with the pandemic still playing havoc with the global economy, caution is required when considering its potential impact on currencies.

According to recent national polls, Biden has a commanding lead (close to a double digit) although we know what happened four years ago when Hilary Clinton was in a similar situation before facing a shocking defeat as Trump managed to win slim (but key) victories in swing states.

In the following analysis we look at the historical and current behaviour of the Dollar ahead and after US Elections and consider the potential repercussions on Sterling and Emerging market currencies.


Dollar and US presidencies


Historically the Dollar’s election behaviour has been fairly consistent since 1980, with USD on average rising in the months leading up to and after the prior ten elections cycles. Also, Democratic presidencies have on average coincided with a stronger Dollar, while Republican terms have largely been associated with relative Dollar weakness.



Source: Forbes



Source: Audere Solutions, Intercontinental Exchange (ICE)



During the first year of Trump’s mandate the dollar fell significantly. Although other factors have also played a role in dragging down the dollar’s value over this time horizon, concerns on Trump Administration’s ability to fulfil its agenda, in particular regarding infrastructure spending and tax-cut reforms as initially promised had a negative impact on the greenback. Since beginning of 2018 and until the outbreak of the pandemic crisis, the dollar has then strengthened, mainly due to a strong US economic cycle and a tighter US monetary policy.

Obviously, the Coronavirus pandemic and subsequent Federal Reserve monetary response has created an abnormal currency environment. As a result, in this report we focus on the medium to long term impact of a Democratic or Republican government, without trying to forecast the course of the pandemic and economic or currency impact.



Volatility during elections

Looking back at the previous two elections (a second Democratic term with Obama in 2012 and a swing to the Republicans and Trump in 2016) a common denominator was a general increase in volatility in the weeks ahead of the vote. This comes as no surprise as political uncertainties and frequent reassessment of polls weigh on asset prices and create market swings.

Leading up to previous elections the 3-month annualised volatility of the Dollar Index was 5.5% in 2012 and 6.3% in 2016. This year we are in a similar situation, with the current level at 5.6%. Interestingly (but not so surprisingly) while EUR/USD was more volatile than GBP in 2012 (7.5% versus 5.0%), in 2016 and 2020 thus far GBP/USD has been the more volatile pair at 11% (2016) and 9.6% (2020) compared to EUR/USD at 6.6% (2016) and 5.9% (2020). We all know why….

The peak in volatility normally comes on Election day (we can call this one Super Wednesday) with currencies responding to exit polls and market sentiment. Interestingly, on both the 2012 and 2016 election days the USD Index initially depreciated in the early morning, before reversing the trend and moving into positive territory thereafter. The amplitude of the movement was very different though, with the 2016 election much more volatile given Trump’s unexpected victory.


Source: Audere Solutions, Intercontinental Exchange (ICE)


Also, on both occasions, GBP/USD reacted less than EUR/USD, providing some evidence that EUR is preferred to GBP when taking a position in the US Dollar.



2012 election – day after election


Source: Audere Solutions, Intercontinental Exchange (ICE)



2016 election – day after election


Source: Audere Solutions, Intercontinental Exchange (ICE)



2020 election


We have seen earlier that by looking at historical patterns, Biden, as the Democratic candidate, would have the higher chances to push the Dollar higher than Mr. Trump.


Rising expectations of a Biden victory is bringing a “calming effect” on market volatility, with a noticeable decline in implied volatility.


On the other hand, we are experiencing unchartered territory in the current pandemic environment, with an unprecedented Global and US recession:

  • The US appears to be the worst-hit country by the pandemic

  • The new President will have to deal with a very high unemployment rate (7.9%) and skyrocketing government debt

While there are several factors to consider when looking at the Dollar's outlook (shifts in market sentiment and the scale and speed of the global recovery from the pandemic) we try to summarise the potential impact of the US election result on the dollar.


A first term Biden


Likely positive dollar

  1. Democratic presidencies have primarily coincided with a stronger dollar.

  2. A Biden presidency would likely see reversals on some Trump administration policies have helped weaken the dollar, in particular the coronavirus response

  3. A tax credit policy for creating jobs in the US could benefit the economy, pushing up the dollar.


Likely negative dollar

  1. Democrat may implement fiscal austerity measures (higher taxes) to reduce US fiscal deficit.

  2. “The increasing possibility of a “blue wave” (Democratic control of the White House and Congress) would result in a bigger fiscal stimulus than currently expected by the two parties.

  3. Less-aggressive protectionist trade policies might accompany a Biden presidency.


A second term Trump


Likely positive dollar

  1. Mix of aggressive fiscal stimulus and trade protectionism were ultimately supportive of the Dollar.

  2. The trade war with China fuelled demand into the dollar, given its safe-haven status.

  3. Tump administration has been promoting a stronger USD in recent years, as another way to promote American exceptionalism.


Likely negative dollar

  1. President Donald Trump's handling of the pandemic crisis.

  2. Isolationist policies could push toward deglobalization and undermine the US dollar predominance for settle transactions.

Many market participants expect some further weakness in the dollar over the medium-term no matter who will occupy the White House, in anticipation of more fiscal and monetary stimulus and a ballooning fiscal deficit. However, it seems like there might be a more bearish outlook for the dollar in case of a Biden victory, especially with a Democratic control of congress. This is based on an expectation of higher taxes coupled with a deficit which continues to grow.


Another Trump term would likely follow the course of the previous one in terms of policy. A mix of aggressive fiscal measures at home and trade protectionism abroad, with additional volatility associated with his unpredictable leadership style and inconsistencies in dollar messaging.


Beyond the U.S. election, the Dollar's behaviour will continue to be subject to shifts in investor sentiment and the scale and speed of the global economy's recovery from the pandemic.



Sterling outlook post-election


While Brexit has fractured the relationship with EU and has been one of the main drivers of Sterling since the 2016 Referendum, the US Election and shape of the future US-UK relationship will also impact Sterling.

Although US-UK relations might improve under a Democratic government over some policy issues (such as climate change), potentially giving some support to GBP, Biden has already warned that he won’t sign a trade deal with the UK unless key clauses in the UK internal market bill are removed. This risks undermining the Northern Ireland peace process.

The big question under a Biden’s presidency is who would become his “special friend” in Europe. Emmanuel Macron is very eager to secure that role, while allegedly a high priority in Biden‘s team is the reestablishment of strong relations with Germany. It seems there are limited plans of handing the UK a preferred partnership status.

This suggests a Democrat win would have a negative impact on Sterling, while a Trump second term would likely be more positive given Trump’s support for Brexit and a future trade deal.



EM currencies post-election


Volatility in Emerging-market currencies has also risen recently, although the pandemic is affecting these currencies too. EM currencies tend to fall during negative news (risk-off environment) and rise when risk sentiment improves.

With Biden’s lead consolidated according to recent pools, many countries which have been targeted by Trump have experienced a strengthening in their respective currencies over the course of the last few months. The Mexican Peso, South Korea Won and Renminbi have been the clear beneficiaries. On the other hand, countries where Biden is expected to take a tougher approach if elected, such as Russia and Turkey, have seen their currency weakening recently, although this may also be due to idiosyncratic factors, especially in the case of the Turkish Lira.

With additional stimulus either from the Federal Reserve or the new government expected to be implemented only gradually post-election, uncertainty will likely endure and we anticipate relatively high levels of volatility for some time. Be prepared!




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