As the Forex Expo kicks off, industry professionals and market enthusiasts are gathering to discuss the latest trends and strategies shaping the currency markets. With the global economic landscape in flux, insights from leading experts are more critical than ever. Charu Chanana, Head of FX Strategy at Saxo Bank, shares insights on the evolving dynamics of the FX markets as we approach the final quarter of 2024.
Trump’s tariff threats and pro-growth policies could push USD higher
A Trump victory is expected to usher in higher fiscal spending, pro-growth policies, and risks of escalating trade and geopolitical tensions. While these factors will likely provide cyclical support to the US dollar (USD), the structural outlook remains more complex.
On the fiscal front, Trump’s pro-growth policies, including higher fiscal spending and tax cuts, will likely bolster the USD by reinforcing the narrative of US economic exceptionalism. Additionally, this could ease the pressure for aggressive Fed rate cuts as recession risks decline and inflation concerns come back into focus.
Trump’s renewed focus on tariffs and protectionism would likely lift the USD in the short term, especially against the Chinese yuan (CNH) and EM FX. Additionally, key commodity-exporting currencies such as the Australian dollar (AUD) and New Zealand dollar (NZD) could face headwinds under stricter trade policies, while the Canadian dollar (CAD) may prove more resilient due to lower exposure to tariff threats.
Geopolitically, a less supportive stance on Ukraine could heighten risk aversion, driving demand for safe-haven assets like the USD, yen, and gold. Meanwhile, European currencies may come under pressure due to rising tariff risks and worsening geopolitics. The Mexican peso (MXN) is also exposed to risks of universal tariffs, given its substantial exports to the US, as well as threats of tighter immigration policies.
While the near-term outlook for the US dollar appears to be positive in the case of a Trump presidency, the long-term structural outlook is potentially more bearish. Rising US debt levels and the risk of threats to the Fed’s independence could weigh on the dollar over time. Moreover, Trump’s aggressive
tariff policies and strained foreign relations may accelerate global efforts to reduce reliance on the greenback as the reserve currency, amplifying risks of structural weakness.
Harris’s status quo will leave the Fed in the driving seat
A Harris presidency would likely emphasise fiscal restraint, with tax hikes playing a key role. This shift could prompt a more accommodative monetary policy from the Federal Reserve, increasing the likelihood of deeper interest rate cuts. The combination of fiscal tightening and monetary easing could be a near-term headwind for the USD. However, the probability of Harris securing a clean sweep remains low. A divided Congress could lead to policy gridlock, hindering significant fiscal initiatives and increasing market volatility. This environment might boost demand for safe-haven assets, such as the USD, Japanese yen (JPY), and Swiss franc (CHF), especially if current stimulus measures face uncertainty in renewals and concerns about a 2025 recession growth.
Harris’ victory might also avoid drastically worsening trade relations, which could initially boost the Chinese yuan (CNH) and other emerging market currencies, weakening the USD amid a risk-on environment. However, China’s economic challenges may limit CNH gains. Similarly, commodity-exporting nations such as Australia and New Zealand could see their currencies rally as risks of worsening global trade relations are priced out. However, medium-term FX performance will largely depend on the broader economic context, whether the global economy achieves a soft landing or slips into a deeper recession.
Fed policy and risks of Yen carry trade reversal
With the Federal Reserve’s beginning its rate-cutting cycle, the USD faces increased downside pressure. While the ‘Dollar Smile’ theory says that a soft landing can mean a softer USD, other major economies must be relatively stronger to attract inflows. However, the German and Canadian economies continue to face hard-landing risks, and China’s growth engines could sputter further if global growth slows. This means Q4 could be bumpy for USD as the Fed cuts rates further, but a sustained sell-off may still be unlikely. Currency crosses like EURGBP (downside) or AUDCAD (upside) could remain interesting in terms of economic and policy divergences.
The Bank of Japan has left the door open for future rate hikes, narrowing the US-Japan yield differential and reversing the dollar-yen carry trade, with the pair already pulling back significantly from summer highs. As we approach the end of 2024, further unwinding of carry trade positions could support more yen strength. However, the pace may slow as the Fed could struggle to meet the market’s dovish expectations if a recession doesn’t materialise quickly. Meanwhile, the BOJ’s cautious stance, with fading yen weakness reducing price pressures, may also moderate yen gains. The case for yen strength remains, bolstered by its safe-haven appeal and the shrinking yield gap with the US, but both the Fed and BOJ are likely to move gradually, keeping yen gains more modest.
CFTC positioning data also reflects the shift we have seen in Q3 with JPY carry bets unwinding, but it does not rule out the scope for this shift to go further. Leveraged funds have sharply reduced their short yen positions, dropping contracts from 114,596 on July 2 to 18,015 by September 3. Asset managers have flipped to long yen positions, moving from -97,951 to +20,272 over the same period. Still, compared to long positions of 14,622 contracts in leveraged funds and 103,196 contracts in asset managers on January 5, 2021, there is a case for yen strength to go further.
