Foreign Exchange: U.S. Dollar Remains Well-Supported

U.S. Dollar to stay strong

The U.S. Dollar is a clear beneficiary of Mr Trump’s victory for three reasons:

Chart 1: U.S. Dollar and 10-Year Treasury yields enjoy a boost post-election

First, President Trump, supported by a Republican House and Senate, will likely implement more expansionary fiscal policy which is pro-growth and could encourage the Fed to hike interest rates at a faster pace than planned and exert upward pressure on U.S. Treasury yields. Fiscal irresponsibility that boost U.S. growth will likely mean stronger U.S. Dollar ahead.

Second, Trump’s tax reform proposals to encourage corporate profits repatriation to fund infrastructure spending plans would be U.S. Dollar-positive.

A temporary reduction in the tax rate on repatriated earnings would likely have a similar impact of boosting the U.S. Dollar as the Homeland Investment Act (HIA) had in 2005. The extent of gains would depend on whether the foreign cash is already in U.S. Dollar or not.

Third, the shock of Brexit and now a Trump victory could fan concerns over European political outlook, which is EUR negative at least against the U.S. Dollar. Brexit and Trump’s election highlights a global trend towards populism and nationalism, which could lead to the break up of the Eurozone. Pro-EU parties are likely now more worried ahead of the 4 December Italian constitutional referendum and Dutch, French and German elections in 2017 (by March, May and September, respectively).

Uncertainty ahead strengthens the case for gold

Political and economic uncertainty ahead strengthens the case for holding gold in a portfolio as a diversifier. But possible changes in fiscal policy that have pushed U.S. Treasury yields higher would offset safe haven demand and temper gold’s upside.

We expect gold prices to trade in a wider range of $1230-$1380/oz on a 3-6 month timeframe.

Emerging Market (EM) currencies likely to come under pressure

Potential trade conflicts and risks of higher U.S. interest rates are a negative medium-term combination for EM currencies and the Canadian Dollar.

Within EM, this concern extends beyond the Mexican Peso, which has been the most prominently vulnerable currency. Wariness will likely increasingly pervade the currencies of many of the U.S. trading partners in EM Asia, most obviously China and Korea.

Beyond the drag on trade-exposed EM currencies, risk of higher U.S. interest rates could trigger bond market outflows from EM. This would make EM carry trade less rewarding, even for the ‘good’ carry currencies such as the IDR, INR, RUB and BRL.

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