FX versus Trump: Too calm for comfort?

Certainly the immediate response has been muted compared with swings seen after the UK’s EU referendum result.

The Mexican peso saw its biggest fall in 20 years as the outcome of the US election became clear, but while the US dollar and other currencies came under considerable pressure in early trading, the FX market’s response was less dramatic than many expected.

This is somewhat surprising, notes ING, considering “Trump protectionist policies will ultimately prove to be a much bigger deal than Brexit in terms of impact on global growth and trade. Hence, the spillover effects into global currency markets may be larger and more persistent over the medium-term.”

Alexandra Russell-Oliver, Caxton FX

The peso was, as expected, the most severely affected, falling by around 14% against the dollar – its biggest one-day drop since the Tequila Crisis in 1994-1995, notes Caxton FX analyst Alexandra Russell-Oliver.

Having traded as low as 18.16 the day before the election, USD/MXN spiked to a new all-time high near 20.78 in Asian trading, as the result became clear, before settling back to trade around 20 in early European trading. EUR/MXN rose around 16%.

Elsewhere the US dollar weakened against the pound and euro, with GBP/USD rising around 1.5%, but overall it was mixed against the majors. The yen and the euro were outperforming, and gold was up 2.4% in early trading, but while emerging-market currencies have been under pressure, here again many of the initial moves were later reversed.

John Higgins, chief markets economist at Capital Economics, suggests the markets might have been better hedged going into the US election than they were ahead of the UK referendum.

“This ‘once bitten, twice shy’ effect would be consistent with the large flow of money out of equities and into bonds since June,” he says.

Alternatively, it might be that markets buy into Trump’s reflationary vision for the US.

Peter Elston, CIO at Seneca Investment Managers, says: “Economic growth tends to be inversely related to economic inequality. If president Trump can fulfil his promises to America’s lower-income groups then there might be a case for becoming more positive on America’s – and thus the world’s – longer-term growth prospects.

“This means that while there will no doubt be a negative response from financial markets to Trump’s victory in the short term, they could quickly recover.”

Traders might also be waiting to see who Trump names in his cabinet for clues about what kinds of policies he will pursue. Given the vague and sometimes contradictory promises Trump has made during his election campaign, there are a number of directions he might take as president.

Evdokia Pitsillidou, easyMarkets

He has given plenty of indications that he favours lower interest rates, says Evdokia Pitsillidou, director of risk management at easyMarkets, citing his observation on the campaign trail that “if we raise interest rates, and the dollar starts getting too strong, we’re going to have some very major problems”. 

However, the devil is in the detail. He might resist the temptation to ramp up tariffs on Mexican and Chinese imports, and content himself with killing new trade agreements and using enforcement clauses in existing agreements.

In that case, the Fed will probably push forward with rate hikes – and likely at a faster pace than it would otherwise have done, says Standard Life Investments (SLI) in a note. That could be in December or early in 2017 if market volatility picks up and the Fed decides to wait for things to calm down.

However, if he pursues a more robustly protectionist policy agenda, the negative consequences for economic activity and corporate margins could easily offset the benefits of fiscal easing.

“This would prevent the Fed from increasing interest rates for some time,” adds SLI. “With particularly disruptive outcomes, the Fed may even consider easing policy. The subsequent effect on inflation expectations and unit labour costs would determine when and how much the Fed tightened once the turmoil subsided.”

So despite the relatively muted market response, there is considerable uncertainty regarding Trump’s plans, and therefore the implications for the economy, the Fed and currencies.

The base case seems to be the Fed will move in December. The Fed Funds futures market, which was pricing these expectations above 85% before the polls closed, fell below 50% once the result became clear, before moving back above 80% as early moves retracted.

However, there is plenty of time for volatility to pick up.

ING says: “Right now, it seems too calm for comfort. While there remain many questions over the Trump administration’s policy agenda – especially in relation to trade and fiscal policy – we suspect the answers are unlikely to be conducive to a recovery in global risk.

“Signs of a protectionist Trump will swiftly see a resumption in the market sell-off and we expect our call for USD/JPY falling to 95.00 and EUR/USD rallying to 1.15 to come into greater perspective. The balance of risks certainly remains skewed to these outcomes and we prefer to fade this starry-eyed optimism.”