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Euro/dollar could suffer if 2016 repeats itself.
Former President Trump has won the 2024 presidential election, achieving a noticeable comeback following the 2020 defeat. The market reaction has been mostly within expectations, with the dollar gaining across the board, gold suffering and bitcoin enjoying strong gains.
While market participants are gradually turning their focus to the Fed meeting for any hints on the rate outlook after Thursday’s gathering, it is worth examining the performance of key market assets from election day until year-end in election years since 2000.
Chart 1 below depicts euro/dollar’s past performance. This pair finished the year in positive territory in every post-election period examined since 2000, with one exception. In 2016, euro/dollar sold off aggressively, finishing the year around 4.5% lower compared to the election date, as Trump’s pro-America agenda boosted the dollar.
As seen in chart 2 below, the performance of the S&P 500 index after election day has been mixed. However, focusing on 2016, the world’s largest stock index finished the election year around 4.5% higher, partly supported by the customary Santa Rally.
Trump’s “America first” agenda is expected to benefit small- and medium-sized US-based corporates. In 2016, this positive sentiment persisted in the post-election day period, with the index finishing the year around 13% higher compared to the election day close. In this context, the Russell 2000 index, which encapsulated small-cap stocks, is expected to perform well today.
Similarly to the S&P 500 index, gold’s performance after election day since 2000 has been mixed, with the precious metal rallying significantly in 2008 but suffering in 2016. Since Trump was first elected in 2016, a possible repeat of that performance could mean that gold could drop towards the $2,500 area.
The pre-US election day period is traditionally characterized by increased market volatility. Based on historical analysis, the VIX index tends to drop aggressively after election day, with 2008 being the exception as the 2007-2008 financial crisis was unfolding. In 2016, VIX dropped aggressively, ending the year around 25% lower compared to election day.
On the flip side, as seen in Chart 5 below, euro/dollar volatility has historically eased in the post-election day period. The only time that volatility remained high and experienced a strong rally was in 2016, when Trump was first elected.
Putting everything together, the performance by key market assets after the 2016 election could serve as a guide to what the future might hold. We could indeed see euro/dollar drop, US stocks rally and gold suffer, but past performance does not guarantee future results. Particularly in a period with two active conflicts, in Ukraine and the Middle East, and China struggling to fix its housing sector issues.
Deglobalization and fragmentation are likely to gather momentum in a Trump 2.0 administration.
In our view, Trump winning the White House and having a largely unilateral ability to implement tariffs and shift U.S. trade policy in a more protectionist direction is yet another deglobalization force. During his first administration and over the course of his latest campaign, Trump has been unwavering in his commitment to tariffs. Time will tell how tariff policy ultimately evolves, but as our U.S. economists note in a post-election report, Trump’s tariff threats should be taken seriously. Global trade cohesion has suffered since the Global Financial Crisis and deteriorated further as a result of COVID. Erecting new barriers to trade will place additional pressure on the interconnectedness of the global economy, which can have longer-term negative implications for global economic growth, especially if retaliatory tariffs are imposed on the United States.
Fragmentation (i.e. countries choosing to strategically align with either the U.S. or China) is a product of deglobalization, and as U.S. trade and broader economic policy becomes more uncertain, strategic alignments could shift back toward China. We observed a noticeable shift in alignment patterns toward China during Trump’s first term, driven by countries opting for stronger trade relations with China, participating in China’s foreign investment programs and voting in unison with China on geopolitical issues at the United Nations General Assembly. With U.S. trade policy likely to turn more contentious and inward-looking, countries around the world could look to strengthen economic and geopolitical ties with China.
Trump will not be able to manufacture dollar depreciation
In our October International Economic Outlook, we noted how a Trump White House would lead us to become more positive on the U.S. dollar. Now that Trump has indeed won the election, we reinforce our view for a strong dollar over the course of 2025 and into 2026, and will become more positive on the dollar outlook in our next forecast update. As far as the dynamics surrounding a more constructive dollar view, in their post-election report, our U.S. economics colleagues noted the extension and possible expansion of the expiring provision of the Tax Cuts and Jobs Act (TCJA) in addition to the likelihood of higher tariffs.
Over the next few years, tariffs and looser fiscal policy could lead to higher U.S. inflation, and through reduced purchasing power of U.S. consumers and businesses, could also contribute to slower U.S. growth. With the Federal Reserve potentially cautious about the overall inflationary implications of the new administration’s policies, the U.S. central bank may lower interest rates more gradually than we currently expect. While there may also be some influence on foreign central bank monetary policy, we think the impact would be far more limited. Slower U.S. growth and tariffs would likely spillover to foreign economies, placing both growth and interest rate differentials in favor of the U.S. dollar over the longer-term. Sporadic bouts of markets volatility could also provide the dollar with safe haven tail-winds over the next 18 months. Also, despite any rhetoric aimed at weakening the dollar, Trump will be unable to influence the long-term direction of the dollar. In our view, Trump’s preference for a weaker dollar would have to be accommodated by and in coordination with the Federal Reserve, which we view as unlikely. We view the Fed as a monetary authority that is unlikely to pursue a weaker dollar at the direction of the President nor have its independence questioned by global financial markets.
This 2024 US election always looked like a very binary event for the FX market. Now that the Republicans have secured both the White House and very likely Congress, we can expect a lower profile for EUR/USD. This largely reflects our pre-election assessment of the global and domestic consequences of a Trump clean sweep, as well as some updated views on the path for ECB and Fed rates.
Our new EUR/USD projections
While there are many structural factors which go into exchange rate forecasting, two of the most fundamental are interest rate spreads and a risk premium. The former can determine asset preferences for financial institutions or hedging costs for corporate treasurers. The latter risk premium is a gauge of how far exchange rates can deviate from financial fair value driven by uncertainty. This is particularly important for the incoming Trump Presidency.
As discussed frequently in our election scenario previews, the likely Republican clean sweep and the prospect for renewed fiscal stimulus have re-priced the Fed landing rate higher. Short-dated USD OIS swap rates priced two years forward rose 15bp in Asia on election day as the Republican success became clear. Instead of the sub-3% terminal rate for the Fed easing cycle expected by the market in September, our team now sees the Fed cutting rates more slowly in 2025 to end at a terminal rate of 3.75%.
What was a little surprising on election day was how quickly the market moved to price a deeper ECB easing cycle. We agree that the prospects of US protectionism in 2025 make it more likely that the ECB will cut rates by 50bp in December this year. And we see a terminal rate of 1.75% in 2025 – perhaps as early as the second quarter of next year – as European policymakers take rates into slightly accommodative territory.
Creating a two-year swap rate differential profile from those central bank views, we see this influential spread staying wide near the 200bp over the next two years. Looking solely at the relationship between EUR/USD and that rate spread over the last 12 months points to EUR/USD not straying too far from 1.05 over the next two years. But now we have to add the risk premium.
Over the last 10 years, we have calculated that EUR/USD can deviate some +/-5% from short-term financial fair value – that fair value is largely determined by interest rate spreads. The task now – in creating a EUR/USD forecast profile – is to estimate the timing of when that risk premium hits.
Speaking to our country and trade economists, we factor in a peak risk premium being priced into EUR/USD in 4Q25/1Q26. Why pick those quarters? We chose this period because it should take about a year for President-in-waiting Trump’s trade team to file trade investigations with the WTO or to conduct internal investigations at the US Trade Representative. That was the case with tariffs enacted against China in 2018.
4Q25/1Q26 could prove ‘peak pressure’ for Europe as the Trump team seeks to secure trade or other concessions from Europe, while tight financial conditions (the US ten-year Treasury yield could be as high as 5.50% around this time) could contribute to softening the risk environment and adding pressure to the pro-cyclical EUR/USD. Our European team feels that the timing sits well with a view that a cohesive support package for domestic demand in Europe only emerges later in 2026 rather than in 2025.
Bringing the rate differential and risk premium story together produces a profile where EUR/USD trades lower than it does now for the next two years. We think it will probably be knocking on parity’s door by late 2025.
Upside risks to this profile stem from either Chinese or European policymakers surprising with sufficient fiscal stimulus (a new German government could play a role here) to move the needle on global demand trends. Or a buyers’ strike of US Treasuries triggering financial dislocation and ultimately lower Fed policy rates. Downside risks – probably more in 2026 – stem from a eurozone recession in response to tariffs (a very difficult environment for investment) and the ECB needing to cut rates much more deeply.
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