he immediate market reaction has been very negative. The Mexican Peso suffered the most, down over 10%. But stocks also fell 4-5% and the Euro rallied against the US Dollar by about 2%. Sterling lagged up barely 0.4%. Emerging market currencies appear to be suffering though, perhaps surprisingly, not against the US Dollar.

The impact will be felt throughout the financial markets. The key will be how far markets fall, in particular equities. If the fall can be arrested at levels not far below those suffered by UK assets after Brexit, the economic fallout may be limited.

Economic policies

Trump’s economic policies have never been fully clear and he has a knack for changing his mind. However, two clear themes have emerged, with contradictory short-term effects on the economy:

1) It is quite likely that restrictions on trade will be forthcoming. The hope is that these will be somewhat muffled by the free-trade leaning (though Republican controlled) Congress. However, the impact on international business confidence will be negative.

2) We are likely to see significant fiscal stimulus in the US next year. A significant tax cut is almost certainly coming. Also, Trump has spoken favourably of generic infrastructure investment.

Impact on currencies

EUR/USD

We’re likely to see a short term rally, at the very least. Whether it’s sustained in the longer term will depend crucially on the response from the Federal Reserve. At any event, this shock will lead us to revise upwards our forecasts for EUR/USD.

Emerging market currencies

Emerging market currencies are likely to suffer a quick fall, followed by a pause while markets wait for further clarity about the intentions and policies of a Trump Administration. It’s possible that these falls will open up opportunities in currencies from countries less dependent on exports to the US.

Chance of a US interest rate hike drops

Odds of a December Federal Reserve interest rate hike have fallen to less than 50%, a rather modest fall compared to the moves we are seeing elsewhere. In addition to the falls in financial markets, Fed speeches in the coming days will be critical to ascertain the impact of a Trump victory on the FOMC outlook.

Stanley Fischer’s speech on November 11th is the first opportunity for the Fed to provide guidance on their policy. Markets will be listening closely.

In the short term it is quite likely that we will see opportunities to enter hedges at very attractive levels in quite a few currencies. However, over a longer horizon, and as in past times of crisis, we expect central banks to do whatever is necessary to calm markets and prevent excessive dislocations, both through communications to markets and direct policy action.

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