Answers to the increasingly likely scenario of Donald Trump winning the upcoming US election on November 5, Deutsche Bank is looking to guide markets, as the recent modest shift in the polls in favor of the former president has prompted increased talk of “Trump trades’ that take place in the market.
But what chance of a Trump victory is the market pricing in now? In Deutsche Bank’s view, while the narrative has changed a lot, the market pricing is much more cautious. There are of course multiple uncertainties about the outcome of US policy, but analysts at the German bank define it as the scenario where an aggressive tariff policy is combined with significant domestic fiscal stimulus. Such a mix will more than offset the negative effects of growth in the US, but not in the rest of the world.
Exchange rate fluctuations
In the exchange rate “universe,” the preferred measure of the probability of Trump pricing is the dollar risk premium over the interest rate differential.
At the height of the 2018 trade war, the dollar was about 10% higher against interest rates. Currently, the dollar is roughly aligned with average rates and has only very recently begun to build a risk premium.
On the EUR/USD front in particular, the fall from 1.12 to 1.09 can be attributed entirely to the Fed’s uptick in expectations from stronger US jobs data and only the move lower than last week can be attributed to changes in US election probabilities.
But, according to Deutsche Bank, a full-scale trade war combined with US fiscal stimulus could bring EUR/USD closer to parity.
In equity markets, a “basket” of S&P 500 companies most sensitive to tariffs has been largely sideways and has only recently begun to underperform, in line with but not beyond recent poll changes.
Interest rates
In central bank pricing, a rough estimate of the level of the ECB’s final interest rates with an aggressive rate policy (1% or less) compared to without (2% or more) should give an equal weighted implied market rate of of 1.50% for where the ECB interest rate could be set.
Likewise, the Fed – ECB spread priced in today is more in line with current estimates for the relative r* at 150 bps. against a potential gap of 200 m.p. and above (Fed at 4%, ECB at 1%) in case of even greater policy divergence if there is a Republican victory.
In conclusion, the market has begun to price in an increasing probability of a Trump victory, but the extent to which this affects market pricing is still fairly modest, Deutsche Bank concludes.
Source: ot.gr
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