What Impact Will A Trump Win Have On FX Markets?

 

Markets Wary Of Outsider Odds

Following on from the issue of Brexit which dominated markets over the first half of the year, attention is now shifting to the upcoming US election. The key issue driving the importance of this event is the potential election of renegade Republican, and famed business, Donald Trump.

Trump has consistently provoked controversy during his campaign with his extreme and polemic views such as his idea to build a “great wall” around America to stop Mexicans from illegally entering the country as he believes them to be “largely criminals.”

However, aside from just making for memorable soundbites and entertaining TV appearances, the issue of his potential election is also highly important to markets. As head of the American Administration Trump is expected to make significant changes to US policy which could have a significant effect on the US Dollar, most notably through Trump’s proposed Protectionist agenda which could isolate the US from its trading partners.

Unpredictable Trump

As Trump is viewed as an outsider having espoused very extreme views and is seen as an unpredictable candidate, markets are viewing his potential election with great uncertainty.  Should Trump succeed in being elected to the US Presidency, this market uncertainty is expected to be amplified leading to an acute period of “risk off trading.”  During such a period traders can expect higher-yielding currencies such as the Australian Dollar, New Zealand Dollar & Canadian Dollar to weaken as investors repatriate capital and move it into traditional safe haven currencies such as the Japanese Yen.  If Trump is elected and markets display a risk-off tone currency pairs such as AUD/JPY, NZD/JPY, etc. are likely to weaken.

Typically, countries perceived as having an unstable political climate suffer investor outflows. However, with the US being the largest economy in the world and the US Dollar being the global reserve currency, it is difficult to properly gauge just how serve this outflow is likely to be though the USD is likely to trade lower in the short term at least.

Whilst Trump has promised to deliver easier fiscal policy with big tax cuts and a significant increase in infrastructure spending, his disruptive policies on immigration and trade threaten the growth outlook which could weigh on USD.

Base Case Scenario

A Clinton win with Republicans retaining their majority in the House is the most likely outcome. This would represent a very little departure from the current political climate and would make it challenging for Clinton to push through policies. However, if Clinton wins and the Democrats also achieve a majority in the house, then this would make it much easier for her to push through Policies.

Clinton has stated her intention to raise corporate taxed and also taxes on the wealthy whilst expanding the Obama care health care program and investing in infrastructure – this would likely lead to a boost in growth and would be USD positive.

A Clinton win would keep the Fed on course to raise rates in December amidst a recession in political risk strengthening USD. At the same time, the removal of risk and uncertainty from avoiding a Trump win would also fuel JPY weakness as risk sentiment improves, driving USDJPY higher.

Outsider Scenario

A Trump wins with Republicans retaining their majority in the House would give Trump virtually free reign to push through policy. Whilst some of Trump’s intended policy such as increased fiscal spending alongside cuts to income and corporate taxes could work to boost growth in the short term, the significant increase in import tariff’s promised by Trump would work against the US Dollar by increasing the price of imports and speeding up inflation, leading to a drop in growth medium to long term.

A Trump win is a little harder to read for USDJPY as Trump’s proposed protectionist policies could lead to a slowdown in Asia and a weakening of commodity markets.

Notably, it seems reasonable to expect USD to rise against emerging market economies and resource-rich economies.  However, the expected risk-off environment created by a Trump win would likely negate the effect that higher US rates would have in strengthening USD and JPY would likely strengthen due to safe-haven inflows.

Trump Win To Weigh On Peso

The Mexican Peso, in particular, looks set to fall against USD in the event of a Trump win due to the proposed trade and immigration restrictions to be placed on Mexico as currently, around 75 – 80% of total Mexican exports go to the United States. The risk is that Trump could pull America out of the NAFTA which he called “the worst trade deal in history”.

The impact of a Trump win on the Peso is evident in the way the currency has reacted over the duration of Trump’s campaign.  The Peso was immediately weaker in response to anti-Mexico comments made by Trump earlier in the year. However, as Trump started to fall back in the polls over summer, the Peso rebounded. Whilst betting markets are now pricing in lower odds of a Trump win; traders are cautious following the recent Brexit vote which occurred against bookmakers odds. As such, short Peso is likely to gather more demand as a hedge to a potential Trump election.