2024 US Election: Should Risk Managers Prepare For Potential Volatility Ahead?

With the US presidential election set to take place on Tuesday, November 5, wild scenarios in FX and credit markets are being tossed around. As of this writing, the race appears to be too close to call. Bloomberg News calls it a “toss-up election”.

“No opinion pollster,” notes Edward Luce, “can drill into the heads of a few hundred thousand swing state voters who do not yet know their own minds”. Given the uncertainty surrounding this all-important election contest, how are corporate FX risk managers preparing?

In this series of blogs, we look at some of the policy proposals that could spark renewed financial volatility. Given that so much is at stake in terms of FX and credit markets, a few legitimate questions arise:

(a) Should FX risk managers concern themselves with election scenario analysis?

(b) Will concerns about forecasting accuracy gain even more ground?

(c) How should CFOs and treasurers prepare in the face of uncertainty? 

Rising appetite for FX hedging

According to a US Bancorp survey of 1,000 US finance executives, interest in risk mitigation is growing, as 60% of respondents say their appetite for FX hedging has increased while just 15% say it has decreased, compared to 6 months ago.

Bloomberg News also reports rising hedge ratios —from around 50%-60% to 70%-80%— at firms involved in ‘nearshoring’ in Mexico. Corporates "are extending contracts for longer than the usual three-month periods through next year to lock in a peso rate below 20 per dollar".

As Kantox’s Esteban López explains, Mexican corporates with sales in the US are looking to implement layered hedging solutions with two goals in mind:

(1) protecting profit margins from currency fluctuations across not one, but a series of budget periods linked together.

(2) anticipating hedge execution to take advantage of favourable forward points, as USD trades at a one-year 5.87% forward premium to MXN.

Before discussing in more detail how treasurers and FX risk managers should prepare, we need to take a closer look at assessments of tariff policy and monetary policy as proposed by the two candidates. 

Tariffs and uncertainty: the wildcard

Harvard University’s Jason Furman sees the economic agenda of Democratic candidate Kamala Harris as “less of the same” when compared to the current policy setup. This is because: (a) she would face stiffer opposition in the US Senate than is currently the case; (b) a Covid-induced type of economic stimulus would not make any sense now.

Ms Harris is also on record for pledging to respect the independence of the US central bank, the Federal Reserve. All of this stands in sharp contrast to the Republican party’s candidate. This is why all eyes are on Donald Trump’s economic program and his plans to raise import tariffs. 

The Republican party candidate proposes increased tariffs, including a 20% across the board tariff on all trading partners as well as 60% or higher tariffs on goods from China. There is talk of a 100% tariff if the dollar is not used—and even of 200% tariffs on some specific companies.

“Tariff,” says Mr Trump, “is the most beautiful word in the dictionary.” His striking proposals reflect the enormous latitude that US presidents have in terms of trade policy.

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Possible impact 

The proposed across-the-board 20% tariff to the rest of the world would likely raise both the cost of consumer goods that are not produced in the US, and that of intermediate inputs to manufacturing. This policy prescription could shrink both imports and exports. 

Would increased tariffs provide solace in terms of the US budget deficit? Scrapping the federal income tax and replacing it with revenues from tariffs on imports is one of the most attention-grabbing proposals on display. Mr Trump has also called for extending the tax cuts enacted in 2017.

Analysts at the Peterson Institute for International Economics estimate that revenue-maximising tariffs on imports can deliver only 40% of the revenue from the income tax to be replaced. Needless to say, this would be bad news in terms of the US fiscal balance.

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Trade Policy Uncertainty: would tariffs solve trade imbalances?

Assuming that tariffs are raised to sky-high levels, would this reduce America’s trade imbalance? Some commentators respond in the affirmative. Others are more sceptical. A study published by Deutsche Bundesbank analyses the impact of the Trade Policy Uncertainty (TPU) that would likely be unleashed.

Trade Policy Uncertainty is an empirical indicator based on news indices that compute the fraction of newspaper articles on trade policy that contain related keywords. There is robust empirical evidence that TPU dampens trade.

As it turns out, Chinese exporters typically respond to US-imposed tariffs —and the resulting TPU— by lowering USD prices to maintain their competitive position. They do so by about 0.75%, on average, in response to a 1% USD appreciation. And that's how tariffs may backfire as an attempt to correct trade imbalances.

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Corporate treasurers and geopolitics

A more aggressive tariff policy from the US could be viewed as a form of economic sabre-rattling. This could then escalate into a full-blown trade war with unpredictable consequences. Recent surveys show the degree to which CFOs and treasurers worry about geopolitical risk, especially in regard to the US and China. 

The US Bancorp survey cited above shows that 32% of respondents flag geopolitical tension and war as a top-three risk, up from 26% six months ago and 17% in 2023. Finance leaders say it is now the third most important business risk. Just 12 months ago it was the least important.

Over at HSBC, economist Shanella Rajanayagam argues that, on the trade front, “geopolitical tensions are seen as the key downside risk. We have been flagging this since the beginning of this year, not only the risk that such tensions persist, but that they could escalate.” 

The recently published HSBC 2024 Corporate Risk Management Survey finds that 47% of respondents see FX risk management as an area they feel their business is least well equipped — a vulnerability that is partly due to exchange rates moving significantly in reaction to unexpected geopolitical events.

In our next blog, we will take a closer look at what Kamala Harris and Donald Trump have to say about the dollar and interest rates, before closing this series with a roadmap for treasurers and FX risk managers.

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