What Trump Means For Currencies

| About: SPDR Dow (DIA)
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Summary

What drives currencies is now politics.

The political pendulum will swing more rapidly than the economic one.

Watch for an underwhelming economic outcome.

Never forget noise - “stuff” happens, and we cannot forecast what the “stuff” will be.

A lot of people have said the election is a game changer. In FX things have shifted dramatically - what drives currencies, (we used to think in cyclical and structural terms) is now politics. In other words, politics is the new economics. In a post- Trump and post-Brexit world, politics is now what dominates FX.

Globally, QE has had a desensitizing effect on bond and equity markets such that markets are less reactive to political developments. However, the low to negative yield world we live in remains driven more by political factors than anything else now that we've had a break from the status quo. Views and forecasts are now more affected by uncertainty and volatility and the political pendulum will swing more rapidly than the economic one.

With a new administration come new fiscal challenges to the outlook. Consensus from the new administration (from plans which have been published thus far) call for spending, tax cuts and public-private partnerships. $5.8tn of tax cuts are set to go to businesses and well off individuals. What this implies is that the multiplier effect is smaller e.g. cutting Buffett's taxes is not going to go drive up spending materially. In today's world, no one is sitting around great investment projects unable to find funding as money is only stationary if sitting in a tax advantaged situation. Meanwhile, infrastructure spending (~$550bn) through PPP is a bit of a question mark as PPPs tend to be complex structures to work thru and the economic advantages are questionable. A lot of the infra spend is on required maintenance and replacing existing infra instead of building new structures. In that regard, the multiplier is small. Thus, I see very limited economic stimulus - a few tenths of a GDP maybe, but certainly not enough to influence the rate outlook. The market on the other hand, is currently pricing in a successful Trump administration and legislation plan. A little optimistic I think considering there will be some lag as the administration spends time figuring out the senate's arcane rules and certainly a more significant lag for stimulus to come through. In other words, watch for an underwhelming economic outcome, a lot less success than the market expects.

What does this mean? Going forward, conditions will be supportive for the dollar as uncertainty drives money flow into safe and liquid havens, allowing the dollar to retain its safe haven status. Political pressure in the near term should drive US rates higher. From a G10 perspective, to have a strong directional FX view, one would need strong political view. Lack of political drivers for the rest of the G10 should keep FX movement sideways in this space- EUR at 1.10 and USD/JPY at 110, save for GBP, which should see significant weakness as a result of the increasingly challenging political outlook post Brexit.

EM FX is a different story entirely - quite a bit of volatility should become the norm, especially for the high yielding pairs. High yielding EM FX will remain volatile and experience strong downward pressure, consistent with UST and core bond volatility. An essential point of the framework for EM is the relatively benign, lagging domestic political backdrop. Consider the Trump change for instance. Trump's comments on trade with China raise question marks with China on the trade & investment channels, fuelling uncertainty in Asian FX and the broader EM framework. In that sense, the US macro policy outlook and how it fits with China will be front and centre for the region. Meanwhile, commodity prices, another key driver, have remained broadly stable (despite energy prices). Overall, the EM currency outlook is under pressure, particularly for high yielding pairs. Vis a vis high yielding EM pairs, the USD should become stronger than consensus. Watch the USD CNY pair which will come under pressure from long term political uncertainty between the US and China post Trump (a rally above 7.0 could well be on the cards). The Indonesia and India currency pairs will come under pressure from carry trade unwinding (look for the USD/INR to rally toward the 70 mark).

Ultimately, people should be interested in the longer term story - lf currencies and bonds are about growth, fiscal policy and what it does for growth, then the stronger dollar today should fade further out along with yields. But let's not forget the noise. "Stuff" happens, and one cannot forecast what the "stuff" will be. Things happen and this should be a core caveat of any FX view.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.