US politics having fair amount of impact on the G10 FX – Rabobank

Jane Foley, Research Analyst at Rabobank, notes that the US politics and upcoming elections are having a fair deal of impact on the G10 FX and volatility is expected to step up moving forward as we close in to the elections date.

Key Quotes

“MXN has become an established barometer of perceived risk of a Trump victory in the November 4 US Presidential election. The rationale is clear. According to the Office of the United States Trade Representative the US imported USD316.4 bln from Mexico last year and ran a hefty goods and services deficit of USD49.2 bln. Similarities can be drawn with Canada, the third country in the North American Free Trade Agreement. The US’s overall trade flow with Canada is a little larger making it the second largest trading partner with Mexico in third place.

Topping the imports from Mexico categories were USD74 bln worth of vehicles last year. Although energy is the US’s largest import from Canada, it still imported USD55 bln worth of vehicles from its northern neighbour. Canada’s auto industry is very sensitive to the competition from stems from cheaper Mexican wages. Indeed, the issue of low Mexican wages lies at the crux of the claims by US Presidential candidate Trump that the NAFTA continues to kill American jobs. While this can be countered by evidence that since the signing of the NAFTA in 1993 US manufacturing exports within the NAFTA have surged, the MXN followed by the CAD are likely to remain highly sensitive to the risk that a Trump Presidency would result in protectionist policies being rolled out in the US.

Protectionism is not the only unknown that would likely accompany Trump into the White House, concerns about foreign policy would also be high on the list. This reinforces the risk that safe haven currencies such as the JPY and the CHF are also likely to be sensitive to the outcome of US political opinion polls in the weeks ahead.

CHF/JPY has been range trading over the past couple of months. However, the downtrend that has existed since the middle of last year is still in place. The SNB makes no secret of the fact that it considers intervention as a policy tool to control the persistently overvalued CHF from speculative interest. The Japanese authorities do not have the liberty to follow suit. Firstly, despite this year’s sharp appreciation of the JPY vs. the USD, the JPY is not an overvalued currency on many academic measures.

Last year the BoJ calculated effective exchange rate fell to its weakest level since 1973. While it subsequently moved higher, it remains relatively soft when viewed from a historical perspective. Also, for many years Japan signed its name to G7 communiques that supported the merits of the market setting FX rates and this year the US Treasury Secretary has pointedly spoken out against FX intervention. While the Japanese authorities are likely to step up verbal intervention on any break of USD/JPY below 100, this may be as far as they are prepared to go. We would see an improvement in Trump’s chances of securing victory in November as increasing the risks of -clear break below USD/JPY 100.

The impact on the USD from US politics is less clear cut. The USD has a flirtatious role as a safe haven asset which likely stems from the attraction of US Treasury paper in times of stress. However, the absence of a current account surplus in the US undermines the USD as a true safe haven. While volatility in the USD crosses is likely to step up in the first instance if political uncertainty increases into the November election we would expect the USD’s medium-term outlook to deteriorate on the view that the market would link protectionist policies with slower growth and reduced prospects of Fed rate hikes. This could further inhibit the ability of central banks such as the ECB, BoJ, RBA and RBNZ to weaken their respective currencies vs. the USD through accommodative policy action and may intensify speculation regarding further policy moves from these central banks.”