In a recent post, we argued that the main way the U.S. election had been impacting international markets was through the U.S. dollar. Indeed, this continued after Election Day as well, with a significant move down in the dollar of 1.4% in the three days after the election was held. This depreciation of the dollar is a reaction to the expected outcome of a Biden Presidency combined with split party control of Congress.
There are 3 main reasons why this downward move in the dollar makes sense:
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- Uncertainty is being dialed down: Just getting through the election and getting closer to an official result represents a significant decrease in uncertainty. In addition, the outcome of a Biden Presidency is seen as a decrease in foreign policy uncertainty, as it likely leads to a return to more predictable trade and China policy. It is important to remember that from when the first tariffs on imports were introduced in January of 2018 to when the Phase I deal was signed between the U.S. and China in January of 2020, the U.S. dollar strengthened by 7.6% against developed currencies and by 16.3% against emerging ones. This is a geopolitical premium that is just starting to unwind.
- Goldilocks U.S. growth: The prospect of a divided government likely means less fiscal stimulus than would have been the case under a one party sweep – and hence more moderate nominal growth. U.S. growth that is neither too hot nor too cold is precisely the right environment for capital to flow to other countries. When U.S. growth is too boomy, capital flocks to the U.S. looking for growth. On the other hand, when U.S. growth is too shaky, capital also flows to the U.S., this time looking for safety. Moderate U.S. growth is the environment where investors need to and feel comfortable diversifying globally.
- Anchored interest rate differentials: Also, as a result of divided government and more muted fiscal stimulus, U.S. short and long-term rates are expected to be anchored at low levels. This means that U.S. interest rates are not moving higher and higher versus other developed markets – and as a result it attracts less capital looking for yield. In fact, it means capital needs to flow out of the U.S. to find income, like into emerging market local debt.
Regardless of the election outcome, the U.S. dollar will remain the reserve currency of the world and U.S. markets will remain a key allocation for global investors. The issue is merely that after a 12 year strengthening cycle, the U.S. dollar is now an expensive currency – and the election outcome can serve as a catalyst for a return to more reasonable valuations. With that said, the election outcome itself can only push currencies so far. After that, fundamentals need to pick up the baton. Here, there is also reason to expect further dollar weakness, as the global economic cycle gains steam in the years ahead and investors look for growth and income globally.
This scenario of a lower U.S. dollar would be a positive one for U.S.-based investors investing internationally without a currency hedge. The currency translation would be a cherry on top of the local asset return, once converted back to U.S. dollars. In addition, a weaker dollar environment is particularly beneficial for emerging market assets, as they are particularly sensitive to currency moves given what they reflect about risk appetite.
More foreign policy visibility, plus a global recovery, should push dollar down
U.S. dollar versus DM and EM currencies, Jan. 1 2008 = 100
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Source: FactSet, ICE ,J.P. Morgan Global Economic Research, J.P. Morgan Asset Management. Data are as of November 11, 2020.