Dollar volatility has been pronounced as the U.S. presidential election approaches, with the dollar’s recent surge driven by multiple factors, notably the renewed optimism surrounding Donald Trump’s potential return to the White House. Dubbed the “Trump trade,” this rally reflects market expectations for policies similar to those during Trump’s first term, which boosted domestic economic growth and deregulation. However, analysts, including those at UBS, advise caution, forecasting that any substantial rally in the U.S. dollar may not last over the medium term. Coupled with this political shift are evolving Federal Reserve policies and global economic trends, all of which play crucial roles in shaping the greenback’s trajectory.

Dollar Volatility: The “Trump Trade” and Its Impact on the Dollar

The possibility of a Trump victory in the 2024 U.S. presidential election has reignited the so-called “Trump trade,” a market phenomenon from his first presidency where the dollar surged due to expectations of business-friendly policies, such as tax cuts and deregulation. Trump’s previous focus on economic nationalism, corporate tax reforms, and deregulation was initially viewed as beneficial for the dollar. However, UBS highlights a critical consideration for investors: the short-term optimism may not translate into sustained gains for the greenback.

According to UBS, while a Trump victory could spur an immediate rally, they advise selling into stronger dollar surges. The Swiss bank projects that the euro-dollar exchange rate could move toward 1.16 by 2025, signaling limited upside potential for the dollar over the medium term. UBS attributes this cautious outlook to Trump’s likely focus on protectionist policies, such as tariffs or trade restrictions, which may create volatility in the global economy and dampen long-term confidence in the U.S. dollar​.

Federal Reserve Policy and the Dollar’s Trajectory

Alongside election-driven factors, the U.S. dollar’s recent movements have been influenced by the Federal Reserve’s monetary policy. In September 2024, the Fed cut interest rates by 50 basis points, marking the first-rate reduction since 2020. This move was aimed at alleviating inflationary pressures and supporting economic growth, a priority throughout President Joe Biden’s administration​.

While the rate cut was seen as a measure to control inflation, it introduced volatility into the currency markets. The Fed’s policy shift reflects a more cautious stance as it seeks to balance inflation management with the need to sustain growth. This has added complexity to the dollar’s performance outlook. While the Fed’s previous rate hikes supported a stronger dollar, the recent cuts may reverse that trend, particularly if Trump’s economic policies add further uncertainties.

The long-term technical outlook for the U.S. Dollar Index, which tracks the dollar’s performance against a basket of six major currencies, also reflects some bearish signs. After a significant rally earlier in the year, the index has shown signs of retreating, especially with the formation of a double top pattern around the 107 level. This technical pattern signals underlying weakness and suggests that the greenback could decline toward key support levels​

China’s Stimulus Measures and Global Risk Sentiment

Amid these domestic factors, global economic events have also influenced the dollar’s performance. Recently, China’s decision to launch two funding schemes aimed at boosting its stock market lifted global equities and increased investor risk appetite. As Chinese stocks rallied, so did commodity-linked currencies like the Australian and Canadian dollars, leading to a pullback in the dollar. The rise in risk sentiment reduced the greenback’s appeal as a safe haven asset​.

Erik Bregar, director of FX and precious metals risk management at Silver Gold Bull, highlighted that China’s stimulus measures temporarily boosted global risk appetite, putting pressure on the dollar. While this pullback in the dollar may be short-lived, it underscores the global interplay between domestic and international factors that influence currency markets.

Emerging Market Currencies: A Promising Alternative?

While the U.S. dollar remains at the center of many investment strategies, UBS advises looking at emerging market currencies for medium-term opportunities. The Mexican peso and the South African rand, in particular, present favorable conditions for investors. The peso has already priced in political risks, while South Africa’s reform-minded government provides a supportive backdrop for the rand. Both currencies offer attractive carry trade opportunities for investors seeking alternatives to the greenback​.

The peso has historically been sensitive to political shifts in the U.S., particularly during the Trump administration, when trade tensions were high. Despite this, the Mexican economy remains resilient, and the peso has factored in much of the political risk, making it an appealing option for investors. Similarly, the South African rand has found support from a government focused on economic reform, which bodes well for its performance in the medium term.

Gold and Commodities: Hedging Against Volatility

As the U.S. dollar’s path remains uncertain, many investors are turning to traditional safe-haven assets like gold. Typically, gold moves inversely to the dollar, with a stronger dollar pushing gold prices lower and vice versa. Given the heightened volatility surrounding the U.S. election and global economic conditions, gold remains a critical hedge for investors.

The price of gold has been fluctuating in recent months as the dollar strengthened, but with the potential for further market uncertainty due to the U.S. election and Federal Reserve policy, demand for the precious metal could increase. Gold’s appeal as a safe-haven asset is likely to grow if the dollar weakens in response to Trump’s potential protectionist policies or a more dovish Federal Reserve​.

Conclusion: Navigating a Complex Market

The U.S. dollar’s recent rally, driven by expectations of a Trump victory and evolving Federal Reserve policies, is not without challenges. While short-term gains are possible, analysts such as those at UBS advise caution, warning that the medium-term outlook may be less favorable. Emerging market currencies like the Mexican peso and South African rand offer attractive alternatives for investors, while gold remains a critical hedge against dollar volatility.

As political and economic factors continue to shape the currency landscape, investors should stay informed and adapt their strategies to manage risks in this complex market environment.