The US Presidential Election has confounded pre-election polling once again. Biden’s recorded lead (as of Wednesday, November 4^th) is much narrower than pre-election polls had suggested and while a Biden victory now seems likely, legal challenges in the days ahead will ensure an element of uncertainty persist for some time. The Senate race has also been a significant disappointment for the Democratic Party, as it appears they have not displaced sufficient sitting Senators to achieve a majority. The ‘Blue wave’ the market had prepared for now appears more of a ‘Blue ripple’ and global currency markets are adjusting to a different political outlook.

The consensus negative outlook for the US dollar under a ‘Blue wave’ was based on 2 key tenants 1) a less confrontational stance on trade between the US and its trading partners 2) large fiscal stimulus leading better global growth and a deterioration in the US twin fiscal and current account deficits. A ‘Blue ripple’ necessitates that expectations of significant fiscal stimulus in 2021 needs to be scaled back as a divided congress will likely struggle to pass fiscal stimulus much above USD1 trillion and this should lead the markets to discount a smaller deterioration in the US twin deficits. However, we differed from consensus in anticipating that after an initial drop, the US dollar would  gain support from higher bond yields and domestic growth under a ‘Blue wave’, which now appears to be less likely forthcoming, even while the medium term outlook for US currency fundamentals remains challenging.

A likely consequence of a Biden administration includes a more conventional approach with regards to policy changes in addition to a less antagonist relationship between the US and its trading partners. The latter would certainly be a net positive for higher-beta cyclical currencies versus the US dollar such as MXN, KRW and CNH in emerging markets and AUD in developed markets. All told, we see a Biden led administration governing alongside a Republican senate as a small net US dollar negative. But, the outlook for the US dollar will be buffeted by equally important Covid-19 pandemic and monetary policy cross-winds.

The path of the Covid-19 pandemic remains key for the market outlook for currencies, especially cyclical ones. Europe once again finds itself in the unfortunate position of being at the epicentre of the Covid-19 pandemic. High frequency indicators of economic activity have started to decline again as governments have put in place measures to attempt to curb infection rates. However, infection rates are also rising in the US as well and it will be difficult for the US to avoid some greater degree of mobility restrictions, similar to those put in place by Europe.

The ECB has already committed to easing monetary policy again at its December meeting, and will consider the use of all policy instruments. A rate cut would likely have the biggest impact on the Euro, although it is not our base that one is delivered in December. Nevertheless, it is clear that the ECB’s tolerance for further Euro strength is limited and that the EURUSD ‘strike price’ for a currency targeted rate cut continues to fall. Meanwhile, given the likelihood of smaller scale fiscal stimulus in the US in the months ahead, the possibility that the Federal Reserve announces an extension of the maturity of its QE purchases at its December meeting is rising. These cross currents likely keep EURUSD within established ranges over the remainder of the year.

Ultimately, the benefactors of the expected ‘Blue ripple’ scenario look set to be higher-beta cyclical currencies in emerging (e.g. MXN, KRW, CNH) and developed (e.g. AUD) markets.  These currencies should benefit the most from the reduction in trade uncertainties associated with a Biden administration, the additional stimulus expected from developed market central banks and their linkages to the Chinese economy where we expect strong growth to continue.

J.P. Morgan Asset Management does not predict outcomes of any political events, nor do we voice firm-wide opinions on any political candidates.