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Deconstructing USD Weakness
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Andrew Kositkun Foreign Exchange Head Trader
The U.S. Dollar Index finished last week lower and currently sits near its year-to-date lows. A key driver of recent dollar weakness is the market’s focus on the significant spending under a unified Democratic government, including hopes for a phase four stimulus package finally getting passed. However, despite the recent run of U.S. dollar weakness, there are some compelling reasons to not fully embrace the view for material and sustained weakness.
The first concerns timing. A phase four stimulus package, in some form, appears inevitable after the election, but its passage is unlikely imminent. Disagreements over the phase four package will still exist after the election and, if anything, could get worse without the motive to score points ahead of the election. This pessimism is reflected in the White House chief of staff admitting that he doesn’t “think our chances get better after [the] election.”
Composition also matters. The potential fiscal boost from Biden’s Build Back Better economic plan will come in the form of medium-term economic reforms that will take time to deliver rather than relief-type near-term spending. Further, like Trump’s Tax Cuts and Jobs Act, Biden’s proposal will take time to negotiate and clear legislative hurdles.
Finally the complete impact of substantial U.S. fiscal spending is more nuanced than risk-on leads to U.S. dollar weakness. Granted, a sizable fiscal boost will be positive for risk and weaken the U.S. dollar through a pullback in safe haven demand. But increased U.S. fiscal spending should improve relative U.S. growth, especially at a time when growth signals elsewhere, including Europe, have started to flash warning signs. This potential for U.S. economic exceptionalism should provide offsetting U.S. dollar support.
On net, a blue wave should lead to modest U.S. dollar weakness, but a lot will depend on global growth conditions and the timing and nuances of the realized fiscal support. The reason why Biden’s fiscal plan should lead to U.S. dollar weakness versus strength after Trump’s fiscal boost is as follows: Biden’s plan also includes tax increases and increased regulation that should dampen the U.S.’s expected fiscal policy–driven growth outperformance. Additionally, Biden is expected to normalize trade and foreign policy. This should weaken the U.S. dollar, as a decline in tariffs should support growth and business confidence and reduce the dollar’s safe haven demand.
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
Global equities are lower, as we are seeing a pullback in risk assets ahead of the U.S. elections. Historically, polling tends to tighten in the last few days ahead of Election Day. Should Biden’s lead narrow materially enough, expect risk-off sentiment to pick up as concerns over a contested election grow, but for now, not much is expected beyond a traditional tightening of the polls as Election Day nears. Speaking of polls, Biden’s chances of winning have returned to over 65%, with the odds of the Democrats taking over control of the Senate around 60%.
Virus numbers continue to rise around the world. Spain is imposing a national curfew, and Italy is planning on shutting down several services and limiting the operating hours of bars and restaurants. In the U.S., White House Chief of Staff Mark Meadows has drawn heat for saying the U.S. will not be able to control the pandemic and will instead focus on treatments and vaccines.
Stimulus talks appear to be on their last legs, although a package before the election was never the expected result. House Speaker Nancy Pelosi and White House Chief of Staff Mark Meadows have accused each other of “moving the goalposts.” Should the Democrats win the White House and the Senate, there would be little incentive for Republicans to pass any stimulus bill, meaning additional help may not reach households and businesses until next year at the earliest.
Brexit negotiations have been extended, with the EU’s top negotiator expected to stay in the U.K. until Wednesday. Talks will then continue in Brussels starting on Thursday. Expect markets to fade negative headlines, as they will be seen as brinksmanship along the way to some sort of deal.
China’s leaders are meeting this week to create the country’s 14th five-year plan that will run from 2021 to 2025. The expectation is that China will continue to emphasize rebalancing the economy away from exports to domestic consumption. This increased emphasis on domestic factors doesn’t mean China’s conflict with the West is over. To this point, U.S.-China tensions are rising again, with China putting sanctions on Lockheed Martin, Raytheon and a unit of Boeing after the U.S. approved $1.8 billion in arms sales to Taiwan last week.
The World Trade Organization formally authorized the EU to impose tariffs on $4 billion worth of U.S. exports annually in retaliation for illegal subsidies to Boeing. The EU isn’t expected to take action until after the election.
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