The upcoming US elections will help determine the outlook for the US dollar and for FX markets in general.
A US president whose party controls both houses of Congress (House of Representatives and Senate) is more likely to push through a meaningful fiscal stimulus than one who has to deal with a divided Congress. In short, a second mandate for Trump together with a Republican-controlled Congress would probably share the same features as the first, with a hawkish stance on trade and fiscal largesse (although the base effect would be less pronounced this time). This would be the most bullish scenario for the greenback over the next 12 months, in our view.
A second mandate for Trump, but without full Republican control of Congress, would reduce the scope for significant fiscal stimulus. However, Trump could make extensive use of unilateral executive orders that increase trade tensions with China and the euro area. While this might not do much for growth, the safe-haven dollar could do well in such an environment, although perhaps not as well as other defensive currencies such as the Swiss franc or the Japanese yen.
A Biden presidency would likely lead to smoother trade and foreign relations together with a more ‘traditional’ approach to decision making. Although Biden may prove quite hawkish on foreign policy, there could be scope for some reduction in global uncertainties, diminishing the attractiveness of the defensive US dollar.
Should Biden win the White House and the Democratic party gain control of both houses of Congress, a fiscal stimulus designed to boost the US economy is likely to be pushed through. However, there is the chance that higher taxes would be introduced a bit later in his presidency, along with other measures that reduce the attractiveness of US assets (such as limits on share buybacks), including the US dollar. In this scenario, cyclical currencies might outperform the US dollar over a 12-month basis.
Overall, our base scenario for the greenback (USD1.25 per euro in 12 months’ time) is most closely aligned with a Biden presidency. Should Trump win, we may have to adjust our projections for the US dollar upwards. However, as we see growth differential as a key driver for the US dollar. A divided Congress or one controlled by one party with a razor-thin majority—the most probable outcome, in our view—does not bode well for ambitious fiscal policies that help push US growth higher. Under this scenario, the growth differential would unlikely be strong enough to lift the overvalued dollar on its own. In other words, the dollar’s prospects would not be significantly altered by the US elections.