FX Focus: DXY – Implications For The Dollar Post US Elections

Following Trump’s emphatic victory in the US presidential election, the broad-based USD Index (DXY) spiked 1.5% in the immediate aftermath of the result to a 3-month high of 105.25. However, FX markets had begun to factor in the possibility of a Trump win as early as late September, reflected in DXY’s gains of ~2.7% during October, supported by higher rates and a rising possibility of a Trump win. The one-day (1.5%) spike in DXY last week, was exacerbated by the Republicans also winning the Senate and looking increasingly favored to hold the House of Representatives (a Red sweep).

However, DXY spike 1.5% intraday, also saw a sharp fall in the FX market’s estimate of future volatility out to year-end, suggesting the DXY may have strengthened enough for the time being and may now likely consolidate around current levels or may even head slightly lower into year-end when markets typically wind down trading activity. Of course, there is still the December Fed meeting to get through, but markets appear to be almost fully discounting a 25bp cut to a 4.25-50% cash rate so higher volatility surrounding the meeting looks unlikely.

However, Trump’s election to the White House does increase uncertainty about the medium-term outlook for DXY. A Red (Republican) sweep of White House and Congress would likely be seen as a green light for Trump to extend his tariffs, re-onshore manufacturing into the US, add substantial additional (supply-side) fiscal stimulus and aggressively enforce immigration law. The combination of domestic demand stimulus through net tax cuts and restrictions on foreign supply is likely to be inflationary and could potentially change the Fed’s reaction function towards significantly lesser or no rate cuts in 2025. It would likely see US rates rising faster than the rest of the world (that feel the disinflationary impact of restrictions on foreign supply) and may strengthen DXY back into a 104 – 106 range (or even higher) over the medium term. 

Even without a Red sweep, markets are still likely to focus on Trump policies executed through Executive Action (tariffs) than requiring Congressional support (fiscal stimulus - tax cuts). The global trade shock due to US tariffs without the offsetting growth-boosting-tailwind of fiscal stimulus for the US economy would likely be negative for global risk appetite and may still imply medium term appreciation of the safe haven USD.

The big question of course is how much of Trump’s stated agenda gets implemented, especially given the campaign promise to also lower inflation. Trump has also explicitly voiced concerns about the current USD strength versus Asian FX (CNY, JPY) in particular. This gives reason to be cautious about Trump’s overall policy agenda as well as in getting overly bullish on DXY over a medium-term horizon.