Seven charts on Trump and FX

Almost everyone agrees on the fact that the election is likely to impact financial markets and the US dollar. However, the directionality between Trump, Biden and the Greenback seems to be less clear. For now, and with four months until the election, lets focus on four key points.

Trump as trade-negative. The pandemic and its effects on the economy make comparisons between the Trump and Biden presidencies difficult. We see the period between 2018 and 2019 as representative of how global trade was impacted by Trump’s tariff increases and trade unfriendly practices. World exports declined on a two-year rolling basis (’18-’19) for the first time since the Global Financial Crisis. US tariffs on Chinese exports increased from around 4% in 2018 to 19% at the end of Trump’s presidency. If reelected, Trump has pledged to impose a broad 10% levy on all products entering the United States from overseas. This should be trade-negative.

Three main channels for FX. An increase in tariffs is likely to be dollar positive via the 1. risk-sentiment and 2. trade slowdown channel. If it turns out to be significantly inflationary and impacts the Federal Reserves bias to ease policy, it would additionally be dollar-beneficial via the monetary policy channel. Keep in mind that the next president will nominate Fed Chair Jerome Powell’s successor.

Politics is impacting markets. The two-year rolling correlation between the Partisan Conflict Index (PCI) and US policy uncertainty & implied equity volatility has been on the rise since 2022 and is approaching its pre-pandemic heights. This is not unusual as disagreements on policies increase in election years. However, it does mean that markets will be more driven by politics compared to non-election years. Policy uncertainty in the United States tends to be elevated in election years compared to non-election years. The current index remains below the historic average, suggesting a potential pickup leading up to November.

Elections have led to regime shifts. There is a statistically significant relationship between currency markets and US presidential cycles. Against the popular believe, the US dollar tends to do better when Democrats are in power.

Still, a change in leadership has often led to a FX regime shift. DXY has risen by around 17% since 2021. If a regime shift (significant change in directionality) takes place after Trump is elected, it would be more likely for it to be a negative one given potential exhaustion of the current upward trend. This would be accelerated by Trump taking a more moderate stance on diplomacy than currently expected, which would allow the Fed to ease policy from Q3 2024 onwards

FX volatility, the US dollar and political uncertainty all tend to rise going into the election month. A change of the ruling party, more than anything else, could spark FX volatility. Markets perceive Trump as dollar positive given his rhetoric on trade and China and plans to cut taxes. This is likely true shortly before and after the election. However, it is unclear if the Trump era dollar gains were driven by the US economy outperforming its peers or specifically the trade war that started in 2018. What can be said is that the global economy is now more vulnerable to shocks than six years ago.