Biden win unravels Trump risk premium

The result of the US election, together with positive news on the virus vaccine, is helping unravel the Trump risk premium that was embedded in the price of the dollar. Despite a split US Congress, Joe Biden’s presidency will help alleviate trade-related risk premia and allow the flow of global trade to pick up. Furthermore, a gradual return to normality thanks to vaccine breakthroughs will see the market pricing a lower risk of further restrictions, and therefore higher growth. All this should be USD-negative; to some extent, however, it has been priced in – mostly in the G10 FX universe. Consequently, we maintain the view of further dollar weakness. However, we believe that a rotation away from G10 and into select emerging market (EM) currencies is brewing.

We keep our target of 1.21 by year-end for the euro/US dollar (EURUSD), and see some further modest gains in 2021. EURCHF should also move higher, supported by improved risk appetite and Swiss residents’ outflows.

We maintain our overweight in GBPUSD. The UK and the EU are inching closer to a deal, which should underpin the British currency for a move towards 1.35-1.37. At the same time, the sharp rally in risk prices has interrupted the downtrend in USDJPY but has not changed the medium-term dynamics. Positive news is already in the price, while the dollar trend has historically been more important for USDJPY direction than have equities. Nonetheless, we acknowledge some upside risks to our forecasts.

The Nordic currencies should remain underpinned by their pro-cyclical nature; we reiterate our call for NOK outperformance. Finally, in G10 FX, the commodity FX bloc will continue to receive support from improved risk appetite, although gains may be modest due to less compelling valuations.

We further revise down our already bearish USDCNY view, now forecasting 6.55 and 6.40 on three- and twelve-month views. Beyond superior macro fundamentals and much improved balance of payments flows, the increasing tolerance of authorities for a stronger CNY is a key reason. With Mr Biden winning, we assume some reduction in trade uncertainty, but do not bet on an automatic or rapid reduction in Section 301 tariffs on China goods. Still, a reduction is plausible, and would introduce further downside risks to our current forecasts.

Using modest energy price assumptions (USD 45 per barrel 12 months out) and inputting consensus EM vs US growth forecasts for H1 2021, our GBI EMFX model suggests that the index could see some gains over H1. We are always guarded when making an index call given the great heterogeneity among the 18-19 countries. However, factors driving some stabilisation of the weakest EM currencies (like TRY and ZAR – see CEEMEA section) – in addition to the potential for improving sentiment on a vaccine – point to some possible gains in Q1 2021. However, low-for-longer energy prices and still-high debt loads will constrain further gains. We maintain our preference for CNY, TWD, KRW, CZK, and PLN. This month, we upgrade CNY and downgrade the PEN and CLP.

Main risks to our views: First, a delay in the development/distribution of virus vaccines could increase the risk of new restrictions and economic disruption. Second, a premature withdrawal of fiscal support. Third, the US Federal Reserve (Fed) turning less dovish.

In the Nordics, we maintain our preference for the NOK over SEK, while in the core commodity FX bloc we now see CAD outperforming. That said, the pace of appreciation of all cyclically sensitive G10 currencies vs the USD is set to slow.

The US dollar-Chinese yuan cross (USDCNY) has now breached the 6.90 – 7.15 range we assumed. This mostly reflects a weaker USD and fast improving Chinese balance-of-payments dynamics, but very recently, markets have begun pricing in a Biden presidency and lower tariffs. We revise down our USDCNY forecast to 6.75 and 6.68 on a 3- and 12-month view. A reduction in tariffs under a Biden presidency would be CNY-bullish, and should see CNH recover lost ground against other currencies, including the EUR.

In emerging markets (EM), we remain structurally neutral on the overall GBIEMFX index, but our forecasts now show a modest spot return of 0.40% on a 12M view,  with the bulk of the gains coming in the next six months (a successful Coronavirus vaccine would help accelerate this process).

Country selection remains crucial, and we continue to prefer currencies with low debt, high exposure to Chinese infrastructure spending (KRW and CLP), EURUSD upside (PLN and CZK), and the tech sector (TWD). In Asian FX, we have upgraded INR to "modestly bullish" and remain "modestly bullish" on the CNY (but would upgrade to bullish if there were more evidence that a Biden Presidency comes alongside a reduction in tariffs).

Main risks to our view: First, a second strong Covid-19 wave that again disrupts economic activity and increases demand for dollars. Second, the euro appreciation may have become an unwelcome development for the ECB. Although the room for policy action is far more limited than in the past, any verbal intervention is likely to weigh somewhat on the common currency and support the dollar. Third, a re-escalation of China-US trade frictions could halt the recovery in global trade and would underpin the greenback.

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