The world will be focused on America tonight, as President Trump looks to overcome the odds (again) and win re-election.  While this election will undoubtedly have major consequences for the geopolitical landscape, the implications for the US dollar are less obvious.  In fact, it will be probably be the speed and clarity of the outcome, rather than the outcome itself, which matters most. 

Even if I had the results of the election today, I’m not sure if I could make money off of it.

Jared Dillian, Author and Financial Commentator, October 28th, 2020 (via Twitter)​​

I don’t think it’s fair that we have to wait for a long period of time after the election.  As soon as the election is over we’re going in with our lawyers.

– ​US President Donald Trump, November 1st, 2020​​

When I said that I think Trump is going to win in 2016, I also said that, if you think 2016 is weird, just wait for 2020.  Well, if you think 2020 is weird, just wait until 2024.  You ain’t seen nothing yet.

Jeffrey Gundlach, CEO, DoubleLine Capital, predicting a Trump victory, October 2020 

Joe Biden remains the clear favourite as we head into election night in the US, although President Trump has been narrowing the gap, criss-crossing the country on an energetic road trip, which at times seems more like a heavy metal stadium tour than a political campaign.  ​​

Trump’s rise in the polls has been modest (from 41% in mid-October to 44% now), but the US prediction markets have moved more aggressively, estimating that Trump now has a 44% chance of winning, compared to 37% in October (Chart I). Broader betting markets are more conservative, giving Trump a 33% chance of winning.  Betting markets also indicate that the Democrats have an 85% chance of holding on to the House of Representatives, and a 60% chance of winning the Senate.  The ‘blue wave’ certainly looks to be the most likely outcome, with a few hours to go.

Chart I: Trump Real Clear Politics Polling Average (Blue) vs PredictIt Implied Probability of Trump Victory (Orange)
Source: Bloomberg

What is less clear is the implication for the US dollar, and FX markets more generally.  A tongue-in-cheek meme that has been floating around the Twittersphere (Chart II) captures this phenomenon succinctly. No matter who wins, the US fiscal taps will be wide open as we head into 2021.

Chart II: US Election Matrix
Source: Luke Gromen, FFTT, LLC

The reality, of course, is slightly more nuanced.  It is likely that a Biden win would mean more stimulus, which would likely have a minor negative impact on the US dollar, at least in the short term.  On the other hand, a Biden victory would increase the chances that the US would follow Europe into a more vigorous COVID economic shutdown, which would likely benefit the US dollar in a ‘Risk On / Risk Off’ environment. 

For what it is worth, I would see a Biden victory being neutral for the dollar in the short term, and negative over the long term.  A Trump victory (with a Democratic Congress) would probably see a firmer dollar in the near term, but the implications over the longer term (> one year) would likely be quite consistent with a Biden administration, as the fiscal deficit becomes a greater concern for international investors.

Initially, what will be more important for FX markets is the time it takes for a clear result to be confirmed, and the potential for heightened political uncertainty surrounding this confirmation.  Over 90 million votes have already been cast, which represents over 2/3rds of the total votes cast in 2016.  Many of these votes will not be counted until after election night, raising the possibility of protracted vote count, involving legal challenges from both sides (think Bush / Gore 2000 on steroids).

Notably, polling shows that while Biden holds a significant lead (66% – 32%) among those who have already voted, Trump holds an even bigger advantage among those who will vote today (69% – 27%).  As early votes will, in many cases, be counted later, this creates a plausible scenario whereby Trump wins on election night (and declares victory), only for this to be overturned in the days and weeks ahead. 

Such a scenario would almost certainly lead to significant volatility in financial markets generally, including FX.  Directionally, the implications for such a scenario are harder to predict.  On the one hand, from a ‘Risk On / Risk Off’ perspective, the US dollar should benefit.  However, it is also entirely possible that such a chaotic domestic political environment could damage the dollar.  Looking all the way back to Bush / Gore, the dollar did initially rally by a couple of cents while the election was contested, before weakening substantially (> ten cents) once Bush was declared the winner.

From a longer-term perspective, a contested and hostile election in the US would almost certainly result in general political destabilization of the world’s largest economy.  As Jeff Gundlach implies above, the likely winners from such an outcome will be risk, uncertainty, and volatility.

Author: Kevin Lester