Post-Election Forex Trading Landscape: Tariffs, Fiscal Policy, & Interest Rates

Donald Trump won the US elections, which was a surprise to some, while expected by others. The pre-election polls painted a picture of a neck-and-neck race, which kept traders on edge or, in some cases, on the sidelines.

On election night, financial markets gradually began to reflect Trump’s victory, and as soon as the numbers continued to confirm, traders' reaction was evident on all the charts. The US dollar rose against all major currencies, treasury yields increased, and the equity markets made new all-time highs.

The elections are over, and the question now is what the post-election landscape can be like for forex traders. Is it going to be a favorable environment? We should look back at Mr.Trump’s first term and campaign promises to answer this question, which may directly impact the markets.

Multiple factors may create a favorable trading environment for forex traders utilizing different strategies.

A trade war occurs when countries try to protect their economies or specific industries by imposing tariffs or restrictions on each other's goods. Tariffs represent an added tax on imported goods, which the end consumer usually pays. The US is the world's largest economy and has had the highest GDP growth for the past few years. The US has free trade agreements with many countries worldwide. The top trade partners include, but are not limited to, China, the European Union, Canada, Mexico, Japan, and the UK.

President-elect Donald Trump promised tariffs on all imported goods, mentioning different percentages on multiple occasions. However, there aren’t many details on how the new administration will negotiate new tariffs and trade agreements.

Although the president has the power to implement tariffs and can do so unilaterally on day one, the administration is likely to take a cautious, informed approach, weighing the options and exhausting negotiations before implementing any tariffs or agreements.

Mr. Trump has also said tariffs can be a bargaining tool if needed.

Countries worldwide are taking Trump’s tariff plans seriously, assessing their impact on their economies, considering alternatives, and looking for solutions.

The bottom line is that it will take more work time and create volatility, which will, thus, provide opportunities for forex traders as they speculate on the impact of tariffs on different currencies' exchange rates.

Depending on the tariff's outcome, many currencies will be impacted, including EUR/USD, USD/MXN, and USD/CAD. The above chart indicates how the market reacted to Trump’s win as traders considered the potential tariff impact.

The above chart shows that the US dollar rose 3.65% against the euro and 1.45% against the Canadian dollar. For the Mexican peso, the US dollar fell 5.2%. However, it went back up and erased most of its losses.

President-elect Donald Trump has spoken of several tax policy changes, including extending the 2017 Tax Cuts and Jobs Act, state and local tax deductions, and a reduction in corporate tax. Congress may approve the changes, or at least most of them.

Expansionary tax cuts increase economic activity but can also lead to a higher budget deficit, which is naturally inflationary. High inflation may alter the FED’s interest rate cut path, as policymakers may have to keep interest rates higher for longer if needed to curb inflation. High interest rates will increase demand for the US dollar, pushing its exchange rate against other currencies. A higher US dollar can help reduce commodity prices and may help with inflation to a certain extent. However, a lower exchange rate for the US dollar can help boost exports and economic growth in the long term.

The Trump administration may rely on spending cuts and tariff revenue to compensate for tax cuts and avoid a more significant deficit. However, the markets may still need to be fully on board, and traders may take a cautious approach to any changes that impact the US dollar and the equity markets.

Forex trading offers various currency pairs. Each pair correlates differently to other markets, offering traders exposure to other markets through different FX pairs.

For example, the daily correlation between the S&P and AUD/USD (or AUD/JPY) over the past 24 months was approx 0.45 - 0.48, while the weekly correlation over the past 10 years was even higher ranging between 0.54 - 0.56. The above daily chart indicates how AUD/USD price action correlates to the S&P 500.

The third theme considered the most important and influential on FX exchange rates, especially at times like this, is the global interest rates and central bank monetary policies.

Global inflation reached a peak in 2022, leading central banks worldwide to take aggressive action by raising interest rates to combat inflation. The Federal Reserve raised interest rates 11 times before pivoting in June 2023. Major central banks have taken similar steps globally.

As inflation declined, the Federal Reserve and other central banks began their interest rate cut cycle, each at their own pace according to inflation data in their countries. The divergence between central bank policies created opportunities for traders to build strategies around interest rate differentials and future inflation forecasts through data releases such as the Consumer Price Index (CPI) or the Core Personal Consumption Expenditure Index (PCE), the FED’s preferred inflation gauge.

The upper pane of the above chart compares US inflation to the Eurozone. It shows when inflation began to rise in March 2020 following COVID-19. It also indicates inflation peaks when the Federal Open Market Committee (FOMC) and the European Central Bank (ECB) interfered and began raising interest rates, when the central banks pivoted, and when the first interest rate cut occurred.

Traders can apply the same chart to any currency pair, comparing how inflation and interest rates impact the current exchange rates.