The race for the White House heats up, but the dollar looks likely to cool

investment insights

The race for the White House heats up, but the dollar looks likely to cool

Stéphane Monier - Chief Investment Officer<br/> Lombard Odier Private Bank

Stéphane Monier

Chief Investment Officer
Lombard Odier Private Bank

Key takeaways

  • Donald Trump could win a second mandate in the White House despite an impeachment process and the unpredictable trade wars
  • On the Democrat side, Joe Biden and Elizabeth Warren are gathering momentum. While Biden would most likely signal a “return to normal”, a Warren presidency could be much more unpredictable
  • Investors should prepare for more volatility as the presidential race heats up in the coming months.

In twelve months we will know if Donald Trump has secured four more years in the White House. It has been a rocky three years so far, a swirl of trade wars, tax cuts, impeachment threats and tantrums. But if you had only glanced at the dollar level at the start of the Trump presidency and again now, you could be forgiven for thinking it had been an era of entirely stable politics. The BBDXY dollar index, which tracks the greenback against a basket of foreign currencies, is at about 1,194.201, just as it was in November 2016 (chart 1). The dollar’s volatility helps tell an intriguing story about the prospects for the US economy, whether under Trump or his soon-to-emerge Democrat challenger in the 2020 race.

In the background of the campaign, Trump will be battling an impeachment process that last week got the go ahead after a vote in the House of Representatives. He is accused of pressuring Ukraine to launch an investigation into potential rival Joe Biden and his son, while withholding USD391 mn of military aid. Meanwhile, the Federal Reserve (Fed) cut rates by 25 basis points but signalled a pause. It is clearly unwilling to make further moves in the absence of significant risks to growth and heightened risks of recession. Trump has criticised Fed chair Jerome Powell for resisting deeper cuts that might reinvigorate the US economy further.

In the background of the campaign, Trump will be battling an impeachment process.

Trump will need a buoyant economy in the election race, but he may be running out of options. After his 2016 election victory, markets expected a fiscal stimulus and a move towards higher rates, which quickly overheated the dollar. A correction in the currency’s value followed, but in December 2017 Trump ignored fears about the deficit to sign off on tax cuts of about USD1.5 tn and a USD300 bn boost to public spending.

Growth differential

There were many criticisms of Trump’s fiscal policy, mostly questioning the sense of lighting a fire under the economy when unemployment rates were already low and falling. But whether by accident or design, the fact that it ran alongside trade disputes instigated by Trump helped emphasise the US’ credentials as a safe haven, which boosted the differential between US growth and that in the rest of the world. That simple fact helps explain the rally in the dollar since early 2018, much to the frustration of Trump, who has expressed a desire for a weaker dollar to help drive exports and deliver the economic boost he craves.

He might be in luck, in an indirect way. Right now, the real world impact of trade war tariffs has helped to put a lid on US growth, with manufacturing a particular trouble spot. At the same time, there does appear to be some movement in the US-China dispute, with a possibility of an interim deal. It might have been signed at this month’s APEC summit in Chile, before it was cancelled in the midst of street protests. Progress here would help global activity to pick up again, reducing that growth differential. This is one of the factors behind our expectation that the dollar will fall back from overvalued levels in the following months as the 2020 campaign gathers pace.


Election chances

Can Trump win in 2020, despite an impeachment investigation, the unpredictable trade wars and a resistant Fed? Yes, he can, and investors will have to be prepared for more of the unexpected events that marked his first four years. According to pollsters at fivethirtyeight.com, Trump’s approval has been locked into the low 40s in percentage terms, while disapproval has been steady in the mid to low 50s. That implies that Trump can still rely on a solid bedrock of support. His eventual challenger will face a fierce fight, even from a president who appears to be on the ropes.

Can Trump win in 2020, despite an impeachment investigation, the trade wars and a resistant Fed?
Yes, he can.

If Trump does get re-elected he will have far less room to introduce new fiscal measures, while the effect of the first lot is fading away. He is, however, likely to focus on a “Made in the USA” policy to boost the flagging manufacturing sector, even if this remains highly sensitive to any escalation in trade tensions. Lurking in the shadows is a rising budget deficit, which now stands at close to USD1 tn after four consecutive years of expansion, even while the economy has grown. It widened by 26% in the last year alone. Opinion differs on how concerned we should be about this, but it is true that the deficit has historically been a headwind for the dollar.


Democratic challengers

We still don’t know the identity of Trump’s Democrat opponent, but the picture is becoming clearer. Joe Biden joined the race late, but has been the front-runner ever since. Elizabeth Warren, the Senator for Massachusetts, is building momentum, in polling and in fund-raising. She has lacked Biden’s name recognition, but is becoming known for spending long hours after campaign events taking selfies with a growing band of supporters.

Biden would represent the most easy-to-read President for markets.

Biden would represent the most easy-to-read President for markets. He was vice-President under Barack Obama, and is known to have maintained relationships across the aisle, even in these divisive political times. His election would mark something of a “return to normal” and might see the US move back towards a Trans-Pacific Partnership (TPP) trade agreement, and rejoin the Paris Climate Accord and the Iran nuclear deal. A Biden Presidency would steady the ship, and would allow dollar valuations to be steered less by presidential intervention, and more by economic cycles, money flows and monetary policy.

Warren is more of a wild card.

Warren is more of a wild card. She would be likely to take on Big Tech, and has stated she wants to break apart monopolies to promote competitive markets. She also promises “Medicare for all” and a wealth tax that could prompt capital outflows. There are clear similarities with Trump in her willingness to “actively manage” the dollar in pursuit of a competitive advantage for US workers and businesses. In general, we would expect a further softening of the dollar under a Warren administration. In European terms her platform is hardly dramatic – Switzerland, after all, has its own wealth tax – but in any case, she will likely be restrained by a divided Congress.

That division, with Congress mirroring the country, will act as a check on any successful candidate. Trump has become used to deadlock, it’s why he doesn’t have his border wall. For the dollar, it is likely to mean that any excesses in presidential policy will be softened by the time they become law. Major disruption should therefore be contained under any scenario.

Major disruption should be contained.

Investors should expect a continuation of volatility as the campaign heats up, although overall we expect to see some of the dollar’s overvaluation to have been pared by next November. Portfolios in this environment should keep a watching brief and prudent positioning, and include adequate downside protections, such as put options on equity indices and gold.

1 Bloomberg Dollar Spot Index (BBDXY), data as of 1 November 2019

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