US dollar will win the election, no matter who ends up in the White House
The world’s addiction to dollar-denominated assets, and supportive US domestic policy, will ensure the greenback continues to rise
The dollar should continue on an upward trajectory during the next US president’s term of office, benefiting from what should be dollar-supportive domestic monetary and fiscal conditions and a continuing global addiction to dollar-denominated borrowings, regardless of who actually wins the White House.
That doesn’t preclude any kneejerk post-election selective sell-off in the dollar if markets are taken aback by the result but it means investors might gain by looking through that price action when making longer term decisions.
As Friday’s US jobs data showed, the United States continues to create new jobs at a healthy pace with the unemployment rate at 4.9 per cent and with October’s data showing, in the words of National Australia Bank, a “jump in average earnings” which “marks a cycle high and the highest annual rate since 2009.”
That seems incompatible with the current level of US interest rates. It must surely be more likely than not that the Federal Reserve now hikes rates next month, making the price of servicing dollar debt dearer.
As far back as January 2015 the Bank for International Settlements was writing that “the scale of dollar borrowing outside the US means that US monetary policy is transmitted directly to the rest of the world in several ways. Changes in the short-term policy rate are promptly reflected in the cost of $5 trillion in US dollar bank loans.”
But in truth, the cost of borrowing dollars in the market has already risen appreciably in 2016.
The 3-month dollar London interbank offered rate (Libor), a measure of the effective cost of short-term dollar borrowing in the global system, has tripled this year to some 0.88 per cent, partly driven by regulatory changes affecting US money market funds as well as by markets anticipating the Fed tightening monetary policy.
Chinese banks and firms which borrowed dollars after the Fed slashed rates in the aftermath of the global financial crisis, but where the loan structures linked the cost of repayments to the 3-month dollar Libor rate, will have been affected.
Paying back dollar loans to avoid higher debt service costs makes sense but almost inevitably creates demand for greenbacks versus the yuan. That may well have been a major driver in the rise of the US currency versus the renminbi in recent months.
The uptick in dollar Libor means the cost to the world of their dollar borrowings has actually risen even before the Fed has hiked. It is, and will be, only natural for the world to continue to buy greenbacks to pay down increasingly expensive-to-service dollar debt.
And like any commodity - for in this context that is exactly what the dollar is - the greater the demand,, the higher the price.
Then there are the likely effects of policies enacted by the next US president, when both major candidates favour, albeit to different degrees, fiscal stimulus which will necessitate increasing US government borrowing and, in all likelihood, trigger tighter monetary policy from the Fed as an anti-inflation device.
Of course the next US president - and again, both candidates may lean this way - might well seek to boost the US economy by drafting legislation that temporarily lowers the rate of corporation tax paid by US businesses, thus encouraging those firms to repatriate money currently held offshore.
President George W Bush’s 2004 Homeland Investment Act (HIA) provided just such an incentive throughout 2005 and the result was a substantial dollar rally over that calendar year.
Goldman Sachs recently estimated that HIA led to an increase in profits repatriated by US corporates of 270 per cent to US$300 billion in 2005 compared to $82 billion in 2004.
As US corporates’ offshore treasuries are by definition the recipients of overseas earnings, it doesn’t necessarily follow that their holdings are just in dollars, where the repatriation process would not have exchange rate implications. If holdings are in other currencies, those would have to be sold for dollars to facilitate repatriation.
In 2005, the dollar index went up throughout the year, because US corporates were converting other currencies to greenbacks and then repatriating them and also because the foreign exchange market climbed aboard the move.
There is no reason to expect there would be any different outcome if the next president of the United States was able to push through a new version of HIA.
Any short term volatility aside, the conditions that support a higher value for the dollar over time will remain, and may even be enhanced by policies adopted after the US election, regardless of who actually wins the White House.