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CBA FX Insights | 29 September 2016
US Dollar: Outcome if Trump Wins
What happens to the USD if Donald Trump wins?
 We (CBA FaX) analyse Donald Trump’s economic policies to make an assessment of what it will mean if he wins
the U.S. Presidency.
 Trump’s economic policies are very inflationary; large income and company tax cuts, government spending and
tariffs.
 We believe U.S. bond yields and the U.S. equity market will lift on the company tax cut, and the USD will surge
higher.
 A 10% lift in the USD will be driven by the capital inflows chasing higher asset price returns. AUD/USD would
decline 10%.
Overview
We do not hold a political view on the candidates in the U.S. election, and none of the authors in this publication are
U.S. citizens or eligible to vote in the U.S. election. We base our economic and financial market forecasts contained in
this report on Trump’s published economic policies, which are summarized in the accompanying table on page one.
Richard Grace CBA Executive Director Currency & Rate Strategy &
International, Economics (Author)
Twitter: @commsec
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CBA FX Strategy - The USD Outcome if Trump Wins
We analyse Donald Trump’s economic policies to make an assessment of what it will mean if he wins the U.S.
Presidency. We make the observation that Trump’s economic policies are very inflationary. Assuming Trump’s
policies pass Congress, we anticipate higher U.S. bond yields, a flatter yield curve, higher U.S. equity markets and a
stronger USD.
Trump proposes to dramatically reduce income taxes to lift household and business spending. The U.S. economy
would grow at a more rapid rate given household consumption accounts for 70% of U.S. GDP. Trump also proposes
to cut the company tax rate to 15%, from its current scaled variable rate of between 15% and 35%. We believe this
would result in a higher re-rating of U.S. equities as increases in net-profit-after-tax valuations surge, generating
larger capital inflows into the U.S. economy.
U.S. corporates would repatriate profits now subject to less tax into the U.S. economy, further lifting the USD. Trump
proposes to boost infrastructure spending and abolish regulations that inhibit job growth. However, there are no
details provided, and the inflationary impulse from these particular policies are likely to evolve over a period of time.
Trump proposes to lift a host of environmental restrictions that inhibit energy investment. While the actual investment
spending is modestly inflationary, the net impact on the oil price is uncertain because increased oil and energy supply
should put downward pressure on oil prices, but the extra demand generated from Trump’s policies will be supplyabsorbing.
Trump proposes to “label China as a currency manipulator”, renegotiate NAFTA and “apply tariffs and duties to
countries that cheat”. All of these policies are very protectionist and would result in higher U.S. import costs, higher
U.S. inflation, and lower U.S. exports even if China and other countries do not retaliate. Some trade would bypass
through third country economies.
Despite the widening in both the U.S. budget and trade deficits under the above outcomes, we think the USD will lift
up to 10% before correcting lower some twelve-months later. AUD/USD would decline by up to 10% as the USD
increases and China’s economy slows by up to 1.0% as exports fall. If the Democrats control the Congress, the
impact on currencies would be less.
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CBA FX Strategy - The USD Outcome if Trump Wins
We the People
On Tuesday 8 November, American voters will elect a new President and members of the U.S. House of
Representatives and Senate. The U.S. election results will be known Wednesday morning 9 November Sydney time.
Recent polls suggest Hillary Clinton is still the favourite to win the U.S. Presidency, but her lead is shrinking rapidly in
favour of Donald Trump (chart 1).
2016 U.S. PRESIDENTIAL OPINION POLLS ODDS OF WINNING THE US PRESIDENCY
(Source: FiveThirtyEight.com)
The U.S. House of Representatives will most likely remain under Republicans’ control according to most polls
(http://www.270towin.com/2016-house-election).
However, the Senate is up for grabs with 24 Republicans and 10 Democrats facing re-election. Currently,
Republicans have control of Congress with 247 seats in the House of Representatives (total of 435 seats) and 54
seats in the Senate (total of 100 seats).
Trumpanomics is inflationary
For the purposes of our economic analysis, we take Trump’s policies at face value. Whether Trump can deliver any
of his policy proposals in part or in full will depend on the make-up of the next Congress (discussed below).
We make the initial assumption that all of Trump’s policies make it through Congress, and analyse the economic
effects of Trump’s policy proposals. We do not take a position on the fairness, ethics or practicality of Trump’s policy
proposals. We acknowledge that our analysis is simple because detail on Trump’s policies are not available, and his
policy positions are subject to change. In brief, Trump’s policies are shown in the table on page one.
The most critical question for us is whether Trump’s policies cause U.S. inflation to increase, decrease or stay the
same? In our judgement, we consider Trump’s policy proposals would increase U.S. inflation in two ways -First,
through demand pull inflation. The very large cuts in tax would stimulate spending, particularly by U.S. consumers.
The reduction or removal of regulation would stimulate business expansion, particularly in energy. The increase in
spending on infrastructure, the military and veterans would increase government spending
Chart 2
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CBA FX Strategy - The USD Outcome if Trump Wins
Demand pull inflation in the current economic environment is “good inflation” because it reflects more spending. There
is a partial offset to demand pull inflation if the Chinese and Mexican governments (assuming tariffs go up under a
renegotiated NAFTA) retaliate by imposing tariffs on U.S. exports. Mexico and China are the U.S.’s second and third
largest export destinations.
Second, through cost push inflation. The increase in tariffs on imports from China and Mexico increases costs for U.S.
businesses and U.S. consumers. The reduction in illegal immigration slows growth in the U.S. labour supply and
increases wage costs for U.S. businesses. Currently, the U.S. unemployment rate is 4.9%, and the U.S. economy is
not far from full employment. Cost push inflation is “bad inflation” because it reflects higher input costs.
There is a partial offset to cost push inflation if Trump’s proposed reduction of energy regulations increases energy
supply, leading to lower energy prices. Overall, we consider demand pull inflation will accentuate cost push inflation
and lead to a net increase in U.S. inflation (chart 3).
Chart 3
Exactly how much U.S. inflation increases, and when, is very difficult to predict. An observation of the current U.S.
economic environment is helpful to illustrate this: despite low unemployment, inflation in wages and prices have been
soft because of low inflation expectations, very poor growth in productivity, and some excess capacity. Faster U.S.
inflation under a Trump Administration will mean the U.S. Fed Funds rate will go up faster, and by more, if Trump
wins. We anticipate the U.S. yield curve would be higher but flatter under a Trump Administration as U.S. short-term
rate rise more than long-term rates
U.S.-China relations under Trump
Trump proposes to “label China a currency manipulator” and impose a 45% punitive tariff rate on all Chinese imports.
Under this scenario, China’s exports to the U.S. could fall as much as 80%. Given 4.6% of China’s GDP is exports to
the U.S. economy, China’s GDP could decline by some 3.4%. We anticipate China’s real GDP growth will slow from
6.7% to 5.7% as U.S. tariffs imposed on China are offset by Chinese domestic stimulus measures. The slowing in
China’s economy would have some flow-on economic implications to the rest of Asia, including Australia.
If the Chinese government decides to take a similarly restrictive trade stance on U.S. exports to China, and levies a
45% tariff on U.S. imports into China, then we anticipate U.S. exports to China would also fall by 80%, from
US$111bn per year to US$22bn. This would result in a further large increase in the U.S. trade deficit, which would be
already under widening pressure from faster U.S. consumption demanding greater imports.
We also believe that the Chinese government could consider imposing tighter capital account controls to curtail the
repatriation of some US$77.5bn in U.S. direct investments, currently held in China. This would be one offset to our
expectation that there would be a large net capital inflow back into the U.S. economy.
Under the above scenario, the disruption to world trade and the global economy could be quite significant because of
the very large global supply chains in the production of internationally traded goods. These global supply chains are
particularly large across Asia. We may also see some offsetting trade pass through third countries in an attempt to get
around country-specific tariffs. If large tariffs are not imposed on China’s exports to the U.S., China is still likely to face
stricter U.S. trade restrictions over intellectual property protection, subsidies to state owned enterprises (SOEs), and
unfair practices in government procurement as well as on environmental and labour standards.
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CBA FX Strategy - The USD Outcome if Trump Wins
In a very diplomatic way, at a press conference in Beijing in March 2016, China’s premier Li Keqiang said ‘no matter
who gets into the White House, the underlying trend of China-U.S. ties will not change. The relationship between the
two countries has always moved forward despite points of disagreement.’
We don’t anticipate the Chinese authorities will dramatically sell their U.S. Treasury holdings. There will already be
upward pressure on USD/CNY from a stronger USD and a slower growing Chinese economy, and this will generate a
competitive depreciation for China. All things equal, China’s USD assets (deposits and Treasury bills) will increase in
value. Nevertheless, we anticipate U.S.-China trade tensions to increase under a Trump Administration.
If a trade war develops between the U.S. and China, it will be harmful to both countries and bring major disruptions to
the global economy. It will be important for the U.S. to recognise that they are already running a sizable trade surplus
in services with China, at US$28bn per year, second only to Canada (chart 4).
Chart 4
Further, U.S. exports of services to China have been
growing at an average rate of 17% per year over the past five years. The likelihood is the U.S. trade services surplus
with China will increase even more rapidly without the imposition of U.S. tariffs because China’s urban middle class is
expected to double over the next decade. Furthermore, China has already passed the “Lewis turning point”, where
labour costs are China is set to rise rapidly, which would make Chinese exports less competitive, narrowing the U.S.
merchandise trade deficit with China.
USD to lift under a Trump Administration
After some initial volatility on the uncertainty, we expect the USD to lift under a Trump Administration for the following
five reasons –
(1) Higher U.S. inflation and higher U.S. interest rates will generate a real appreciation in the USD. U.S. interest rates
will go up faster and more, under a Trump Administration, generating a relative rise in U.S. interest rate differentials
(chart 5) and a flatter yield curve (chart 6).
Chart 5
Chart 6
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CBA FX Strategy - The USD Outcome if Trump Wins
(2) Capital inflows will increase under a Trump Administration because the cut in the company tax rate will generate a
surge in U.S. equity indices and offshore residents will be looking to purchase U.S. equities that are now generating
significantly higher net profits after tax because of the large cut in the company tax rate. The “re-rating” of U.S. equity
markets will generate a capital inflow into the U.S. economy similar to that which occurred under the late 1990s “dot
com” period (chart 7).
Chart 7
Chart 8
(3) Capital inflows will increase under a Trump Administration because the cut in the company tax rate will generate
repatriation of U.S. profits back into the U.S. economy. The cut in the U.S. company tax rate from as high as 35%
down to 15% will be lower than the tax rate in most offshore locations. We witnessed a similar USD appreciation
when the U.S. government introduced the 2004 American Job Creation Act, which contained large tax credits for U.S.
companies bringing back offshore profits into the U.S. economy.
Today, U.S. offshore profits account for a much larger share of the U.S. economy (3.8% of GDP) compared to 2004
(1.8% of GDP), so the appreciation impact on the USD could be even larger (chart 8). Trump’s proposed reducedregulation would presumably also encourage more U.S. businesses to bring manufacturing back into the U.S.
economy.
(5) We anticipate an initial narrowing in the U.S. trade deficit as the “easily imposed” Trump policies of labelling
“China as a currency manipulator” are quickly implemented, helping to support the initial USD lift. China accounts for
US$472 billion (or 21%) of U.S. imports. Presumably Trump’s renegotiation of NAFTA would also result in reduced
imports from Mexico, which accounts for US$113 billion (or 13%) of U.S imports (chart 9).
Chart 9
Chart 10
Collectively, China and Mexico are the first and third largest U.S. import partners, accounting for 54% of the U.S.
trade deficit (chart 10). We anticipate the legislative bills necessary to pass the U.S. income tax cuts would take a little
longer to implement. Hence, over a twelve-month period, we would anticipate the initial narrowing in the U.S. trade
deficit to reverse and widen for two reasons: (i) because a reasonable proportion of U.S. exports contain imports into
the U.S. production process, and; (ii) because Trump’s polices of cutting the income tax rates and boosting
infrastructure spending would result in an increase in consumption and capital imports, widening the trade deficit. This
is a typical pattern of behaviour in the U.S. trade deficit when the U.S. economy grows faster than the rest of the
world, and would remain so even if selected tariffs are introduced (chart 11).
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CBA FX Strategy - The USD Outcome if Trump Wins
Chart 11
Chart 12
Increased U.S. domestic energy investment should lower the U.S. energy import bill requirements as locally-sourced
energy needs are substituted. But we anticipate there would still be a net widening in the U.S. trade deficit based on
stronger U.S. consumption (chart 12).
Chart 13
Chart 14
(5) The U.S. terms of trade should technically lift under a Trump Administration because higher U.S. tariffs should
result in overseas companies lowering their export prices (i.e. generating lower U.S. import costs) in order to partly
offset the imposed tariff by the U.S. government. The actual tariff itself is not calculated in the U.S. terms of trade
equation. The income collected from the U.S. tariff would go to the U.S. government. We also anticipate the increased
U.S. domestic energy investment would lower the volume of U.S. energy imports, which would end up generating a
positive impact in the U.S. terms of trade equation. The net increase in the U.S. terms of trade would assist the
appreciation of the USD (chart 13). We anticipate the initial twelve-month appreciation in the USD would be in the
order of 10%, taking the real USD trade-weighted index to fresh cyclical highs. However, the medium-term widening
in the U.S. trade deficit, and the real appreciation in the USD would slow the U.S. economy and lead to a reassessment of the extent of Fed interest rate increases. This in turn would slow and reverse the USD appreciation
after a twelve-month period (chart 14).
The inevitable widening in the U.S. budget deficit from the Trump tax cuts may result in a U.S. sovereign ratings
downgrade. However, similar with the USD impact from the previous U.S. sovereign ratings downgrade, we don’t
expect this would result in a dampening effect on the USD.
USD scenarios under two different Congress outcomes
The above outlines what we believe would happen to the USD if Trump could successfully implement his policies. But
the post-election make-up of the U.S. Congress will determine which policies Trump can implement. We envisage
different outcomes for the USD, depending on how the U.S. Congress is made up in the post-election period.
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CBA FX Strategy - The USD Outcome if Trump Wins
Scenario 1 – a “Trump light” Administration: In this scenario,
Trump is elected President, but the Democrats win the Senate. This is moderately USD bullish because Trump would
have difficulty passing all his pro-growth economic policies.
Scenario 2 – a “Full-Metal Trump” Administration: In this scenario,
Trump is elected President and Republicans remain in control of Congress. This is the most USD bullish scenario
because Trump will face significantly less obstacles in implementing his economic and foreign policy platforms.
It is important to recognise that Trump is unlikely to get all of his rather radical policies through the Congress.
Passage of bills through the Senate is also likely to take some time. Hence, the inflationary impact of Trump’s policies
would take some time to flow through to the real economy and generate the real appreciation on the USD. We are
also assuming some of Trump’s stated policies such “a return to the gold standard” and “a lift in the minimum wage”
are not enacted, because these policies are not currently on his website.
Impact on AUD/USD under a Trump Administration
We anticipate AUD/USD could decline by up to 10% over a twelve-to-eighteen month period because of a stronger
USD, weaker China and Asian economies, and some downward pressure to Australian energy commodity export
prices (chart 15).
Chart 15.
AUD/USD may receive some offsetting support as U.S.led global equity markets lift (supported by the cut in the U.S. company tax rate). AUD/USD may also receive some
support from higher base metal commodity prices driven by stronger U.S. economic growth. We also believe that the
decline in the AUD will reduce the chances of additional RBA rate cuts.
USD & U.S. Presidents
Historically, the USD has tended to appreciate when a Democrat is in the White House, rather than when a
Republican is in the White House (chart 16). The USD spiked up during Ronald Reagan’s (Republican) first term in
office (1980-1984), which involved large tax cuts, largely because Fed Chair Paul Volker was raising interest rates
aggressively to tackle runway U.S. inflation.
Chart 16.
Chart 17
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CBA FX Strategy - The USD Outcome if Trump Wins
During Reagan’s second Presidential term (1984-1988) the USD fell sharply, triggered by the September 1985 Plaza
Accord (the international agreement to depreciate the USD).
Historically the USD has not performed particularly well when the same party (either the Replication or Democrat
party) was in control of both the White House and the Congress (House of Representatives and Senate) (chart 17).
Between 1993-1995 (during the 103rd Congress), Democrats controlled both the White House and Congress, and
the USD major trade-weighted index fell by roughly 6%. Between 2003-2007 (the 108th and 109th Congress)
Republicans controlled the White House and Congress, and the USD major trade-weighted index declined by about
19%.
Richard Grace Global Markets Research | Foreign Exchange Strategy: Strategy
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