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Could the US election prove to be a huge USD positive?

Chris Weston
Head of Research
19 oct 2020
They say in trading that if you can get your USD call correct then you’re halfway to understanding where equities and commodities are going. This goes to show just how important the US currency is.

The USD in a ‘Blue Wave’ scenario

One of the biggest and more interesting debates is whether the so-called ‘Blue wave’ scenario - that being Joe Biden becoming US President and the Democrats getting both the House and the Senate - proves to be positive or negative for the USD.

According to election polls, forecasters models and betting markets, a ‘Blue Wave’ is the most likely scenario, with betting site Predicit pricing a 58% chance of this scenario playing out. Of course, there’s scepticism about the accuracy of the polls and the race for the Senate seems almost too close to call.

However, given it’s the most probable scenario many have looked at the impact this outcome would have on the USD.

Trade US Majors with us

(Predicit’s probability of a ‘Blue Wave’ market - currently at 58%)

(Source: Bloomberg)

The bearish case for the USD

On one hand, conventional wisdom suggests a ‘Blue Wave’ would be a USD negative given Biden would have smooth passage to pass a massive $3.5t fiscal stimulus. This stimulus would cause the US budget deficit to increase significantly and would cause US bond yields to sell off (yields rise) as inflation expectations move higher.

The result?

Given the US government's massive deficit funding requirements and subsequent sensitivity to higher interest rates, we’d see the Federal Reserve step in and do more asset purchases, or ‘Quantitative Easing’ to suppress bond yields.

This would see yet another rapid expansion of the Fed’s Balance sheet, which would be taken as a USD negative, especially against the MXN, AUD and CAD. Even if other central banks are following suit and doing forms of easing.

The idea that the Democrats would also raise corporate taxes to 28% would lower the US’s competitive advantage and drive capital out of the US.

(Daily chart of the USD)

The bullish case for the USD

The other school of thought, which is certainly non-consensus is that a Democrat clean sweep (or ‘Blue Wave’) would actually be positive for the USD. If we look at the daily chart of the USD (above), we see price moving sideways since late July, and has broken out of the bearish channel – for a market that is considered to be part-pricing in a ‘Blue Wave’, we’re not seeing the USD weakness implied by the USD bear case above.

In fact, if we look at USD positioning we can see speculators have reduced USD shorts and are running a small net long position. Again, hardly a market that has seen a greater chance of a Blue Wave, resulting in the USD being savaged.

(CFTC report – USD speculative positioning)

(Source: Bloomberg)

If anything, one could argue that the combination of massive fiscal stimulus, a relatively higher inflation rate, and a US central bank who are pro-actively seeking inflation, could result in the US becoming a Mecca for global capital again.

It could even be the best house in the neighbourhood, or the least dirty t-shirt if you will. A place where global funds will be magnetised to the relative compelling growth differentials (in the US) and the ability for corporates to grow earnings and pay better dividends.

Perhaps the consensus view is incorrect, and instead of a weaker USD, a ‘Blue Wave’ reinvigorates the investment thematic of US exceptionalism, This would be a massive USD positive. And perhaps you see the USD and gold price rising together as inflation expectations lift.

The logical expression of this trade is long USD vs the ‘funding’ or ultra-low interest rate currencies, such as the EUR, JPY and CHF would work. Long MXN and CAD may work as the US’s biggest trading partners but look to trade these against the EUR or NZD given the US growth dynamics.

The USD goes lower in gridlock

One could argue then that the weaker USD story comes in a scenario of Congressional gridlock. That being, a split Congress, with the Democrats getting the House and Republicans retaining the Senate. Subsequently, any fiscal package will take time to pass or pass in a far smaller form, and the Fed will therefore be required to do far more. Whereas regardless of who is President, the inability to smoothly pass legislation keeps capital from flooding into the US – perhaps this is where we see the USD gravitate lower.

This election is divisive, not just in voting trends but on how traders see the USD reacting to various outcomes. Pick your side and take a position with us. Trade gold against five different currencies, FX majors and US indices with low spreads and fast execution today.

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