News and events

08.28.2024

A REPUBLICAN SWEEP COULD OVERTURN USD WEAKENING IN 2025

On the FX space, we think the major impact on the USD of a Trump presidency could derive primarily from the US-China trade war channel and, on a lesser extent, from the US-EU one.

​​Given that FX plays as the intermediary between countries in international trade, in a world of largely free-floating exchange rates, any actual material government-imposed restrictions should result in a consequent reassessments of exchange rate levels.

We see the terms of trade (ToT) channel as the most important driver of FX valuation following the imposition of tariffs. A tariff acts as a fee paid on imports, which is either absorbed by corporations or passed through to consumers.

Evidence shows that since 2018, foreign currencies have broadly weakened against the USD (Figure 1), largely benefiting foreign exporters. Under an upcoming second wave of trade wars, we therefore expect that these corporates, which benefited from local currencies devaluation, would be more willing to drop prices to maintain volumes, as they did during the increase in tariff levels in 2018. As a result, our baseline assumption is that US imposed tariffs by an incoming Trump administration would likely act as a positive terms of trade shock in favor of the USD.



Evaluating tariffs through the lens of the ToT also intrinsically captures the relative elasticities of goods. Countries that export m ore elastic goods would be more vulnerable to tariffs, as price changes would have a larger impact on demand. Hence, as a general rule, we expect exchange rates to be more sensitive to ToT for those countries which export more elastic goods rather than less elastic ones.
To empirically measure elasticities of goods, we considered what happened during the previous trade war under the Trump presidency. Therefore, first of all we estimated elasticity of China’s share in US total imports (Figures 2, 3).
The Eurozone was not immune to the global trade dispute unleashed by the US administration in 2018 too. Some industrial sectors (such as steel and aluminum) were heavily impacted, while the overall direct FX impact for the regional economy was contained, as only around EUR6.4bn (less than 1% of EU’s GDP) in EU exports were affected. Furthermore, in 2021 the Biden administration replaced Trump’s tariffs on steel and aluminum with a tariff-based quota system, where the below-quota EU export has been exempted from US tariffs.






Valerio Ceoloni
Senior EM/FX Strategist
Investment Research




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