Bank of America Merrill Lynch stated that tax cuts and tariffs provide short-term support for the US dollar, while central bank selling, verbal intervention, and trade agreements weaken the dollar. In the event of a Republican presidential victory, preliminary higher tariff pricing will have a positive impact on the dollar; in the event of a Democratic victory, the dollar will weaken relatively slightly and return to data-driven and Fed policy-based trade.
The overnight usd rose to a three-month high, how will the usd perform after the USA election, the usd trend after Trump's victory in 2016 provided a reference for the market.
In its report on Wednesday, bank of america pointed out that after the USA election in 2016, the usd began a roller-coaster trend, immediately strengthening after the election in November 2016, but sharply weakening in 2017, then strengthening again in 2018 and 2019, influenced by multiple factors affecting the usd:
Tax cuts and tariffs support the usd, while central bank sales, verbal interventions, and trade agreements weaken the usd.
It is worth mentioning that tax cuts and tariffs may still be favorable for the usd in the short term, but may be unfavorable in the long run.
Considering the above influencing factors, bank of america analysis points out:
Reviewing the historical political cycles of the USA, comprehensive victories by the republican party have often led to higher interest rates, thus strengthening the usd, while comprehensive victories by the democratic party have had the opposite effect. However, in cases of government division, the impact is mixed.
In this election, in the case of a victory by the republican party president, preliminary pricing of higher tariffs is likely to have a positive impact on the usd, while other scenarios have far less direct impact on the usd.
In the event of a Democratic victory, the US dollar is expected to weaken slightly, as the market will price out tariff risks, and the dollar is expected to return to data- and Fed policy-based trading. However, the long-term outlook for the dollar will still depend on whether and how the US resolves its deteriorating debt situation.
The US dollar's 'roller coaster ride' after the 2016 US presidential election.
Regarding the US dollar's trend after Trump's victory in 2016, Bank of America stated that the dollar experienced severe fluctuations:
Although the dollar immediately strengthened after the election, it weakened significantly in 2017, then strengthened again in 2018 and 2019, ending 2019 below the level after the 2016 election. During this period, the USD index fell by 2.1% after excluding the impact of the pandemic, or by 4.5% when including the pandemic impact.
It is worth mentioning that in recent years, global central banks have been selling US dollars and reducing their dependence on the dollar:
Despite the Fed's rate hikes, the dollar weakened in 2017, partly due to significant selling of US dollar reserves by global central banks, which disrupted the correlation between the dollar and Fed policy rates in 2017.
Since 2016, central banks have accelerated their sales of US dollar reserves, a trend that normalized after 2020. This is related to the decline of the US's share in the global economy.
As for why the US dollar began to appreciate in 2018, it is related to tariffs, according to Bank of America:
The tax reform was passed in December 2017, and the United States began to implement tariffs in 2018, these measures supported the US dollar in the short term.
After the mid-2019, the US dollar began to weaken again, reasons include the Federal Reserve began to cut interest rates in July 2019, President Trump's criticism of the Fed's rate hikes, and market expectations that the US and China may reach a trade agreement. Meanwhile, central banks continue to sell US dollar reserves.
Tax cuts and tariffs provide short-term support for the US dollar, while central bank sales and verbal interventions weaken the dollar.
Although history does not necessarily repeat itself, the lessons from the impact of the above policies on the US dollar during this period are still relevant. Bank of America concludes that tax cuts and tariffs have supported the US dollar. The Fed's policy is indeed important, but there are also counteracting forces, verbal interventions impacting Fed policy/ or countering the strength of the US dollar have had a negative impact on the dollar. In addition, central bank sales have also put pressure on the US dollar.
The impact of this election on the US dollar, US dollar forecast:
Apart from the initial positive response of the US dollar to higher tariffs in the event of a Republican president victory, the impact on the US dollar in other scenarios is far from direct, much will depend on policy details and timing, as well as how other regions around the globe react, including central bank reserves.
In the event of a Democratic victory, it is expected that the US dollar will weaken slightly because the market will discount tariff risks. The dollar will return to trading based on data and Federal Reserve policy. However, the long-term outlook for the US dollar will still depend on whether and how the US resolves its deteriorating debt dynamics.
Looking back at the historical political cycles in the USA, comprehensive victories by the Republican Party have often led to higher interest rates, resulting in a stronger dollar, while the opposite is true for comprehensive victories by the Democratic Party. However, in cases of a divided government, the impacts are mixed.
