Our US Public Policy and Currency experts discuss how different
outcomes in the upcoming U.S. elections could have varying
effects on the strength of the dollar.
----- Transcript -----
Ariana Salvatore: Welcome to Thoughts on
the Market. I'm Ariana Salvatore from Morgan Stanley's U.S.
Public Policy Research Team. And I'm
Andrew Watrous: And I'm Andrew Watrous, G10
Currency Strategist.
Ariana Salvatore: On this episode of the
podcast, we'll discuss an issue that's drawing increasing
attention from investors leading up to the U.S. election -- and
that is the U.S. dollar and how a Harris or Trump administration
could impact it.
It's Thursday, August 15th at 10am in New York.
Earlier this year, Morgan Stanley experts came on this show to
discuss the current strength of the US dollar, which has had
quite a historic run.
Now we all know there are numerous ways in which politics could
affect the currency. But before we get into the details there,
Andrew, can you just set the stage here a little bit and give
some context to listeners on where the dollar is right now and
what's been driving that performance?
Andrew Watrous: Yeah, the dollar's been
rising this year. So, if you look at a trade weighted gauge of
the US dollar, it's up about 3 percent, so far. And part of that
US dollar strength is because growth expectations for the US have
risen since January. There's a survey of Wall Street economists,
and if you look at their median forecast for the US growth, it's
moved up about one percentage point since January.
And as a result of that strong US growth, we've seen Fed policy
expectations move higher. We started this year with the market
pricing the Fed to be below 4 percent by December. And that
expectation for where the Fed is going to be in December has
moved up about 1 percentage point since January.
So, robust US growth and a higher near-term Fed policy rate
expectation have made the US more attractive as an investment
destination. And that's boosted the US dollar broadly as capital
flows to the US.
Ariana Salvatore: That makes sense. Now,
thinking about the balance of the year, it's impossible to look
ahead and not consider how the US election could impact or change
this trend that you've been talking about. As we get closer to
November, investors are also starting to question just what will
happen to the dollar in a Republican or Democratic win. What's
been our approach to thinking through that question?
Andrew Watrous: So, if you look at policies
proposed by the Republican presidential campaign, a number of
those policies, if implemented, would probably boost the US
dollar.
First, higher tariffs on goods imported from our trading partners
could weigh on expectations for growth abroad. That would make
the US more attractive in comparison, maybe send capital to the
US as a safe haven due to policy uncertainty. And of all the
scenarios we look at, we think that one where the Republicans
control both Congress and the White House would be the scenario
in which the federal government spends the most and issues the
most debt.
More spending would likely make US growth expectations and bond
yields higher in comparison to what we'd see in the rest of the
world. So, a Republican presidential administration could attempt
to offset some of that US dollar strength; but in the near term
we think that the US dollar should go up if a Republican White
House looks increasingly likely. And on the other side, the
dollar could go down if the likelihood of a Democratic White
House looks increasingly likely -- as some positive risk premium
around trade and fiscal policy is reduced.
Ariana Salvatore: Okay, so you mentioned
quite a few policy variables there. Let's take those issue areas
one by one. On trade policy and geopolitical risk, it wouldn't
surprise us from the policy side to see a potential Trump
administration introduce tariffs, just given the rhetoric we've
seen on the campaign trail. We've talked about the potential
impact from 10 per cent universal -- targeted or one-for-one
tariffs -- which all come with varying degrees of economic
impacts.
On the currency side, Andrew, walk us through your thought
process on how the risks to growth expectations from tariffs
could factor into dollar positive or negative outcomes.
Andrew Watrous: So, a lot of our thinking
on this is shaped by what we saw in 2018 and 2019, when there
were trade tensions. During that period, the dollar moved higher,
starting in spring 2018 until the end of 2019, and a big part of
that dollar strength was probably due to trade tensions between
the US and China. Those tensions meant that investors were
probably more hesitant to take on risk outside the US than they
otherwise may have been. That's why the US dollar kept rising
during that period, despite the Fed cutting rates three times in
2019. And in 2018 and 2019, we saw expectations for growth in
countries outside the US moving lower -- in part because of trade
tensions during that period.
So, from speaking to my colleagues in the economics department
here at Morgan Stanley, it seems pretty plausible that something
similar happens to expectations for growth outside the US, again,
if another trade war looks increasingly likely. And that drop in
what people expect for growth outside the US would probably boost
the US dollar as the US looks more attractive in comparison.
Ariana Salvatore: Got it. Now, shifting
gears slightly to the fiscal policy outlook. We've said that the
Republican sweep outcome is the most likely to lead to the
greatest degree of fiscal expansion, and that's because we think
lawmakers are going to have to contend with the expiring Tax Cuts
and Jobs Act. We think that in a divided government outcome, or a
Democratic sweep, some of those tax measures are still on the
table, but it'll probably be a narrower extension from a deficit
standpoint.
So, Andrew, what would a fiscally expansionary regime mean for
the dollar?
Andrew Watrous: So, as you mentioned, the
most fiscally expansionary scenario would be a Republican sweep
scenario. And we did some research into capital flows; and the
Treasury data show that historically, higher US spending is
associated with net inflows of private capital into the US. And
if you look at the pace of US spending versus the pace of
spending in Europe, if you look at that differential -- that
differential is positively correlated to movements in Euro. So
faster US spending means lower Euro relative to spending in
Europe.
Ariana Salvatore: So, we expect that a
Republican administration's policies might strengthen the dollar
in summary. But it's possible that they don't like that dollar
strength. We've heard Trump talk about the benefits of a weaker
currency for exports, for example. So, what might a Republican
presidential administration try to do to maybe offset some of the
strength?
Andrew Watrous: Yeah, so if we’re right and
the Republican policies do strengthen the dollar, that Republican
administration could try to offset that dollar strength with a
number of policy tools. And those might be effective in weakening
the US dollar against one or more of our trading partners. But we
don't think that the market expectation of those dollar negative
policy options would fully offset the effect of other Republican
policies, which would boost the dollar.
There are legal, logistical, and political challenges associated
with a lot of those dollar negative policy options. So, for
example, former US Trade Representative Lighthizer has reportedly
expressed doubt about the viability of broad international
coordinated intervention against the US dollar. He said that no
policy advisor that he knows of is working on a plan to weaken
the dollar. And former President Trump reportedly rejected a 2019
proposal to intervene against the dollar from former White House
Trade Advisor Peter Navarro.
Ariana Salvatore: Got it. So, sounds like
we have a lot of moving pieces here and we will keep refining our
views as we get some more policy clarity in the coming months.
Andrew, thanks for taking the time to talk.
Andrew Watrous: Great speaking with you
Ariana.
Ariana Salvatore: And thanks for listening.
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