Recent developments have reinforced the factors that have supported the strength of the US dollar over the past decade, but the upcoming US election could change this direction significantly, according to Goldman Sachs strategists.
Goldman said tariffs, which play an important role in the foreign exchange (FX) market, are expected to be the focus of various election scenarios.
Specifically, the bank noted that the US dollar may show a strong reaction in the event of a landslide victory for the Republican party, which could lead to larger tariff increases and domestic tax cuts. On the other hand, the Republican government is expected to trigger a smaller and limited strengthening of the US dollar.
Meanwhile, a major Democratic or Republican victory "is likely to cause initial weakness in the US dollar as markets reassess the prospect of more drastic tariff changes," strategists said.
They believe that currencies sensitive to China and policy changes, such as the Mexican Peso (MXN), Chinese Yuan (CNH), South Korean Won (KRW), Euro (EUR), and Australian Dollar (AUD), will find some relief after recent market movements.
The firm's research shows that under the policy scenario of a US tariff increase on China with a Republican government, the Chinese Yuan could depreciate to around 7.40, and the Euro could depreciate by about 3%, or even up to 10% in the case of a global tariff increase along with a reduction corresponding tax.
“Fundamental analysis generally shows a smaller currency exchange impact than event studies or policy-focused analysis, so we think investors should be cautious with estimates based on the 2018-19 experience. We expect the market will not fully reflect tariff expectations immediately," Goldman's team said in a note.
"Thus, we are more inclined to perceive long-term trade-offs in Republican decisions than Democratic ones," they added.
Goldman emphasized that US policy is only one of the main factors shaping currency market perceptions.
The bank sees an upside risk to their forecast of a gradual depreciation of the US dollar from its peak in 2022, citing continued 'US exceptionalism'. However, they also expressed downside risks if China's stimulus efforts had a bigger-than-expected impact on rebalancing global growth.
