As FOREX traders, we’ve closely followed the BREXIT issue during the first part of 2016. BREXIT’s effects on the markets (especially on the currency markets) resulted in many trading opportunities! We then shifted our attention to the US election and its impact during the 2nd semester of 2016. Here again, market participants haven’t underestimated the importance of this event and its moneymaking opportunities.
On Election Day, the surprise victory of Trump had an intense and abrupt effect on worldwide indices. After the results, stock markets fell sharply, but recovered and finished in the green. It was the same as with the BREXIT vote: market participants had bet until the last moment on the option that seemed the most favourable: a victory for Hilary Clinton. But as Bloomberg noted before the results came out, the day after the US election is always extremely volatile.
The FOREX market also had put up with extreme volatility. On Trump’s election day, the American Dollar reached a low point at 95.906, before rising and ending at the highest level of that day’s session, at 98.64. The Mexican peso, a proxy for US election sentiment, plunged more than 12%, reaching a record low near 19.88. The Japanese Yen, a safe-haven currency, strengthened to 101.15 before coming back down to 105.85.
Trump will assume his role as chief executive of the United States next week on Friday the 20th of January. Let’s see how we can still use the “Trump Effect” to improve our FOREX trading performances in 2017.
How To Use The Trump Effect To Increase Your FOREX Performance
At first, market’s participants thought of Trump as an unpredictable candidate. He is still seen as having very extreme views, so his election was associated with great uncertainty.
Uncertainty is one of the things we fear the most as traders. The instability that uncertainty can generate on the markets leads to higher volatility. This can be dangerous without proper money-management rules.
Trump’s shifting positions on many issues doesn’t allow us to predict a clear post-election scenario. Given all the potential surprises, it’s not easy to prepare any US economic forecasts for the year. But since his election, Donald Trump seemed to have moderated his tone and controlled his behaviour, which market participants have had appreciated since then.
His economical program
Donald Trump plans to decrease taxation of high and middle-income earners (39.6% to 25%) and change the number of personal income tax brackets from 7 to 3. For individuals, inheritance, gift and federal estate tax should be abolished. Taxes on capital gains and dividends should be reduced to a 20% maximum rate.
Trump has spoken previously of lowering company tax from 35% to 15%. He is also planning to abolish tax loopholes and create a tax on corporate profits that will be earned abroad. Trump also wants to encourage companies to repatriate wealth held abroad. He plans to offer a one-time repatriation tax of 10% of corporate profits held abroad, payable over 10 years. Overall, the corporate tax bill would decline by more than $3 trillion over 10 years, or 1.6 percentage points of the American GDP.
This could generate a major boost for the American economy. Indeed, American multinationals, which have their headquarters in countries more fiscally advantageous, will be tempted to go home. The significant tax rate cuts would also boost incentives to work, as well as to save and to invest. This latter will depend on the evolution of interest rates though.
Massive Investment in Infrastructure
Trump is planning a massive program for investing in infrastructure (rebuilding roads, bridges, schools, tunnels, airports and hospitals). $550 billion would be invested to revive gloomy American growth and to renovate infrastructures “neglected for too long”.
Those “deficient” infrastructures will roughly costs $3,400 per household per year by 2025, according to American Society of Civil Engineers (ASCE). The latter computed that the total requirements would be up to $3,600 billion by 2020.
Mark Zandi, chief economist of Moody’s Analytics, said that if you have major tax cuts and a strong increase in infrastructure spending, the benefits of this plan could quickly go away as the effects become negative in the long run.
How or whether the tax cuts will be paid for is unclear. To fully pay for the cuts without adding to the federal budget deficit, government spending must be reduced by 20%.
Forecasts show that Trump’s infrastructure investment plan will increase public debt dramatically to around 130% of GDP within 10 years. Conversely, the economy could expand significantly as a result of his other proposals, thus making the debt ratio much lower than current projections.
But as said by Mark Zandi: “Trump’s economic policies hurt the economy due in part to the large budget deficits and heavy debt load that result from his tax and spending policies”.
Trump wants big changes in trade policy and he is clearly opposed to free trade. He heavily criticized the trade deals made by the US in the last decades: NAFTA, China’s entry into the WTO, the TPP agreement, among others.
He wants to implement a more protectionist policy, especially with new tariffs on Chinese and Mexican products. 45% on Chinese products, until China decides to allow the Yuan to freely float. 35% on Mexican products imported from companies that are outsourcing American jobs to Mexico.
Rising uncertainties on Trump’s policy results
You have different ways to assess macroeconomic consequences of Trump’s victory.
You can see his policies on immigration, taxes cuts, government spending, and international trade as you will find them on the website of his campaign.
You could also assume that Trump’s policies will be adopted on a smaller scale than what he currently proposes.
Or, and this is probably the most likely scenario, Trump will have to negotiate in some way with Congress. In that case, Trump’s policies might have to be scaled back.
But in any case, there are some things we can conclude from his policies. For example, it’s highly probable that some of Trump’s economic policies will hurt the American economy, especially because of his “large budget deficits and heavy debt load that result from his tax and spending policies”.
If Trump sets up his protectionist economic program, this could lead to higher inflation. The US imports almost $500 billion in goods a year from China, and almost $300 billion from Mexico. According to Moody’s Analytics model, “slapping a 45% tariff on Chinese imports and 35% on non-petroleum Mexican imports will increase overall goods import prices by roughly 15%. This in turn lifts overall U.S. consumer prices by almost 3% at its peak six quarters after import prices increase”.
Consumer Price Index, or CPI, is one index that measures inflation, which is a sustained increase in the general level of prices for goods and services in a given economy. There are different causes of inflation with 2 principal theories: demand-pull and cost-push inflation. The demand-pull theory assumes that if the demand for a good is higher than the supply, then prices tend to go up. The cost-push inflation theory occurs when companies increase prices if they have to bear higher production costs.
Printing money is also considered to be a cause for inflation. If the money supply increases faster than the real economic output, then inflation will likely occur, as everything will then be more expensive.
Trump’s effect on monetary policy
Trump’s large tax cuts and wider deficits might actually support consumer spending and economic growth at first. But we might rapidly see negative impacts rising, especially from higher interest rates caused by the important deficits and higher inflation.
The Federal Reserve‘s dual mandate is about maximum employment (unemployment rate at 4.8%) and price stability (PCE index at 2%). With Trump’s policies, inflation is expected to rise faster, and could thus accelerate towards the 2% FED target.
As could be seen with the FED’s minutes of the December meeting, FED members are already anticipating the $500 billion stimulus and investment plan announced by the future President of the United States.
The FED’s member’s also highlighted the “considerable uncertainty about the timing, size, and composition of any future fiscal and other economic policy initiatives as well as about how those polices might affect aggregate demand and supply”.
Even though the FED is saying that interest rate hikes should remain “gradual”, we cannot ignore the fact that FED members are already thinking of raising rates faster than expected to prevent the economy from overheating and to contain inflation…
All of this bring us to the moneymaking opportunities on the FOREX market.
Winners and losers on the FOREX market in 2017
As we have often highlighted in previous articles: “investors’ expectations with respect to monetary policy decisions (easing or tightening) will have an impact on a currency”. So, as investors are expecting the FED to increase rates, they will look to invest in the US dollar.
Higher interest rates will attract foreign investors, which will result in an increased demand for the currency of the country and therefore a strengthening of the currency against other currencies. Another way of seeing it: higher interest rates will increase borrowing costs, money availability on markets will diminish, and the value of a currency should then increase.
But there is no clear view on how Trump’s policies are really going to be implemented. Thus, we can’t have a view over their consequences. It’s hard to forecast the American dollar evolution in the medium to long term. It is likely, however, that the evolution of the US dollar will be volatile and reactionary in the short-term. Any opportunity or challenge to the American economy will affect the American currency.
For some, currencies of emerging economies might be an investment to stay away from because of global uncertainties. But for others, it could be a real opportunity if you understand the dynamics of individual countries within the global landscape, as those currencies have suffered throughout 2016. In any case, monitoring how Trump’s administration will handle international trade deals in the coming year is essential for traders.
The Russian Ruble might benefit from increasing oil prices and improvements in its relationship with the US. As Trump said in his 1st press conference since he was elected: “If Putin likes Donald Trump, guess what, folks, that’s called an asset not a liability”. Once in office, Trump could also end Obama’s sanctions against Russia, as “it’s time for our country to move on to bigger and better things”. He has always been in favour of closer relations with Russia, and “Russia can help us fight ISIS”.
During his press conference, Trump confirmed that he hasn’t softened his stance on Mexico. The new US trade policies will negatively impact the Mexican peso, as Trump wants a more protectionist trade policy. As we said above, he wants to implement a 35% tariff on Mexican products. He also wants to build a wall between the US and Mexico to avoid immigrants illegally entering American territory. Trump said that he would make sure that Mexico pays for the wall. This will probably continue to put pressure on the Mexican peso, which reached a record low of 22 on Wednesday.
Over in Europe, the sterling has had a difficult start to 2017, which reached its lowest level since October. Investors will closely watch all BREXIT developments, as Theresa May said she would trigger Article 50 during the 1st semester of 2017. Trump was in favour of a BREXIT – after the results came out, he said that it was a “great victory”. Hard Brexit negotiations will weigh on the pound, as Theresa May wants to give priority to immigration control over the advantages of the single market.
The U.S. and Europe have the largest bilateral trade and investment partnership in the world. Any changes that occur in American policies will have a deep impact on their respective economies, and thus, on their currencies. As an example, Europe is the US’s top trading partner (more than US$600 billion in goods exchanged in 2015). But as Trump is against expanding trade deals in order to limit competition against American industries, this will likely impact commerce between the two regions. On top of this, the European currency will have to deal with many political uncertainties this year. The French presidential elections, the legislative elections in Germany, the new Italian government, the Hungarian presidential election, and United Kingdom local elections can all have an impact on the EUR, especially with nationalism sentiment rising.
You need to closely follow any further developments of Trump’s administration. Trump has said that he will pass some important bills within the first 100 days of his presidency. Any changes in his policies will have an impact on the FOREX market. On the other side of the Atlantic, you should closely monitor the BREXIT timetable and discussions around BREXIT negotiations. Be also mindful of all the 2017 elections in Europe.
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