Theorizing about how the U.S. election might impact financial markets has become a favorite pastime of market strategists.
Now, a team of fixed income and emerging-markets analysts at Societe General have come together to offer their two cents about how the outcome of the election could impact the currency market—specifically the dollar and emerging-market currencies, which have been part of some of this year’s most popular trades.
The team, led by Vincent Chalgneau, the bank’s head of fixed-income strategy, and Guy Stear, its head of emerging markets, concluded that a Trump victory would likely hurt emerging-market currencies as investors brace for more protectionist trade policies in the U.S. Indeed, many emerging-market currencies are already responding to tightening election polls, it appears. The correlation can be seen in the graph below:
The Mexican peso (USDMXN) one of the most vulnerable in this space, has fallen 10% against the dollar since the beginning of May, when a Trump victory in the primary looked all but assured.
At first glance, a long-term chart of the dollar’s performance suggests that Democratic presidencies have been more supportive for the greenback.
But there are exceptions. Take the early 1980s, when Fed Chairman Paul Volcker’s aggressive response to stagflation led to a stronger dollar as he raised rates sharply. President Obama’s first term is another exception: the dollar weakened in the aftermath of the financial crisis as the Fed slashed interest rates and launched a series of bond buying initiatives.
Overall, though, the historical data suggest that the dollar (DXY) would strengthen after a Clinton victory, with the biggest moves coming if Clinton wins but Republicans retain control of Congress.
“If the central scenario sees a Clinton victory and a split in Congress, then the historical verdict is not bad for the dollar. It is even better in a Clinton/Republican Congress scenario,” the strategists said.
But there’s one important complicating factor: By at least one measure—the Peterson Institute’s FEER, or fundamental equilibrium exchange rate, model—the dollar was overvalued by about 7% in April, which translates to an overvaluation of 9% today.
The dollar as measured by the real effective exchange rate, however, is right in the middle of its range for the past 30 years. Finally, during the two periods of remarkable dollar strength—in the mid-to-late 90s and during the past few years—the Asian crises, European sovereign crisis, and global monetary policy played key rolls. The U.S. political cycle likely had limited impact, the analysts said