Mid-terms: Are currencies more sensitive to trade, taxes, or other Trump policies? Experts have their say

US President Donald Trump tweeted that he had a good conversation with his Chinese counterpart Xi Jinping. Later, he reportedly instructed his cabinet to prepare a trade deal with the world's second-largest economy and a trade rival. Stocks surged and some suspect it is only an election ploy.

Markets do not only care about the trade but also about tax cuts and other topics. We put three questions to six experts and received fascinating answers. This is the second article out of three in ahead of the vote on November 6th. The first was about the US Dollar reaction.

Here are the other two:

• Will the Dollar rise on a Republican win or just do its own thing? Experts weigh in
• Mid-Terms: Can Democrats change Trump's trade policies? Experts are divided

Ed Ponsi

Ed Ponsi CMT, CTA, states that trade matters most and emphasizes the stark difference between China and Canada:

Trade matters most. Look at the positive reaction of the Canadian dollar to the recent USMCA agreement. The Canadian dollar gapped higher in an explosive move when an agreement with the U.S. was announced.

Now, look at the spiraling markets in China, where no agreement is imminent. Stocks are down over 20% year to date, and the yuan is nearing 7:1 vs. the dollar, its lowest level in years.
The juxtaposition here is very stark. With an agreement in hand, Canada is flourishing, and with no agreement in sight, China is sinking. There are other factors at work here, but this is hardly a coincidence.

John W. O'Donnell

John W. O’Donnell, from the Online Trading Academy, says both taxes and tariffs are important:

Low taxes in the US are bullish for DXY, but a trade war hurts all currencies as tariffs are taxes on finished goods.

Barbara Rockefeller

Barbara Rockefeller, from Rockefeller Treasury Services, notes the impact of taxes and trade but says the Fed is the ultimate market mover. She discusses the option of Trump firing Powell. 

How sensitive is the FX market to various policies? The FX market is still figuring out how it feels about various Trump policies. We recently learned about the huge new deficit (almost $800 billion), due almost entirely to the tax cuts, but it failed to move the market an inch. What did move FX was an aggressive-sounding Fed. Outrageous trade policies tend to favor the dollar—and we are getting a move against China from a 10% tariff to the 25% version, possibly ahead of the midterms instead of the scheduled January—because of fear and risk aversion. This is not a “good” reason and tends to lack staying power, hence getting revived and revisited fairly often.

The real institutional mover is the Fed, not presidential policies. That means that the question of whether Trump will fire Fed Chief Powell is on the table. Article 10 of the Fed Act says the president can remove the Fed president “for a cause.” Trump has no problem stretching the truth, or making up lies, to find “cause.” At a guess, Trump may name a too-strong dollar that harms exports as “cause.” He probably doesn’t know and certainly doesn’t care that dollar matters “belong” to the Treasury. This is not going to happen anytime soon, however, but is likely in January.

Joseph Trevisani

Our in-house expert Joseph Trevisani lays out the factors moving currencies with interest rates topping the list. Policies on trade and taxes do have a role, as well as "jawboning" by officials.

Interest rates have the most direct impact on a currency and central bank rate policies remain the best predictors of long-term movement in the currency markets. Rate policies are multi-year cycles and are viewed in comparison to the policy of the opposite member of a currency pair. Rising interest rates in one currency improve the return on holding that currency and on instruments denominated in it, creating demand in both long and short-term markets and in the speculative precincts of the international currency markets. The greatest impact tends to be around changes in policy when markets must adjust to differences well out on the yield curve. These adjustments often happen in relatively brief periods of heightened volatility.

Policies that encourage or inhibit trade between nations can also impact a country's currency. This can be done directly with tariffs, as in the current dispute between the U.S. and China, or by reducing the value of one's currency in order to obtain better terms of trade and thereby increase exports. In China's case, the downward pressure on the yuan came from market expectations of a poorer performance from the export-dominated Chinese economy given the more expensive access to the U.S. market. The yuan is a managed currency and the devaluation was enacted by the People's Bank of China.

Government officials or central bankers may attempt to move markets in a particular direction with rhetoric designed to support a specific policy without actually implementing said policy. Often called 'jawboning' its effectiveness diminishes rapidly if no actual policy changes are forthcoming

Domestic economic, fiscal or tax policies can also move a currency depending on the real or perceived impact on the economy. Policies that improve growth tend to be supportive and those that retard or diminish the same can devalue a currency. The connection to a currency is through central banks policy as an expanding economy is more likely at some point to warrant higher interests to fend off inflation.

Mike "Mish" Shedlock

Mike "Mish" Shedlock, from Sitka Pacific Capital Management, lists the Fed as a market mover but stresses that things never happen in a vacuum. ECB action and policies on Iran also play a critical role: 

I suggest is not what Congress does that is meaningful, but rather what the ECB does, what Trump does with tariffs, what Trump does with Iran, and what the Fed does with interest rates that matters most. 

In a vacuum, Fed hikes are dollar-supportive. However, this isn’t a vacuum. Even if the Fed hikes, if they hike slower than expected, it would tend to weaken the dollar.
As of October 23, the market thinks there is a 78.8% chance of a hike in December with a 53.8% chance of another hike in March.
If either of those does not happen, look for the dollar to weaken. Housing is faltering now. Homebuilders are getting clobbered. I suspect that March hike may not happen. Heck, the December hike may not happen. 

But once again, this is looking at things in a vacuum. The Fed does not exist in a vacuum. One needs to consider other central bank actions, especially the ECB.
The ECB is expected to taper in 2019. But what if they don’t? That would tend to weaken the Euro vs the dollar.
 

Dr. Woody Johnson

Dr. Woody Johnson, from the Online Trading Academy, talks about the policies that Trump can enact and their impact, but also on what Democrats can do to limit his policies and also government shutdowns, investigations, etc.

The president’s party has historically not fared well during midterm elections, and the results could affect the likelihood of certain pro-growth measures such as the so-called Tax Reform 2.0, which could include making individual tax cuts permanent and create new incentives for retirement savings and research and development. Democratic majorities could make for more confrontation, including government shutdowns, investigations into Trump administration activities and even the threat of impeachment, which could unsettle markets, at least temporarily. Currencies are likely to be more sensitive to trade, tariffs and tax fluctuations after the midterm due to the close relationship between currencies strength and or weakness as it relates to policy.

Stay tuned for our third and last of the series of expert opinions.