"Dollar-supportive Political Risks are Sill Simmering in the Background"

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If the Republicans win big in November, expect a surge in import tariffs to underpin the U.S. Dollar further.

This is according to Corpay, the international payments firm, ahead of next week's Republican national convention.

"Beyond making capitalisation rules great again, we suspect that the prospect of renewed protectionism will represent an increasingly material menace to currently low levels of implied volatility in foreign exchange markets," says Karl Schamotta, Chief Market Strategist at Corpay.

Schamotta thinks the next administration's increasing protectionism will bolster the Dollar and potentially work against President Donald Trump's efforts to lower the U.S. trade deficit.


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The U.S. imports more than it exports, aided by a cyclically strong Dollar, increasing the trade deficit from $74.5BN in April to $75.1BN in May.

The Republicans will target the $1 trillion-a-year trade deficit in goods by supporting baseline tariffs on foreign-made goods, passing the Trump Reciprocal Trade Act, and responding to unfair Trading practices.

They think tariff revenues will fund tax cuts on domestic companies and workers. Trump has mooted lifting tariffs by 60% on imports from China and by 10% on all other imports.

Schamotta says this will reset trade barriers to levels last seen in World War Two.

"As dozens of previous attempts have shown - all the way back to the Corn Laws in 1815 or the Smoot Hawley Tariff Act of 1930 - protectionist policies tend to slow global growth rates without addressing the underlying causes of imbalances," says Schamotta.



 

In this case, he warns higher barriers could perversely widen the trade deficit (just as they did during the first Trump administration): if the U.S. economy becomes increasingly isolated from global markets, domestic inflation pressures might rise.

This would necessitate tighter policy from the Federal Reserve and drive the dollar higher.

Schamotta says the currencies of exporting countries will fall, making them more competitive in nominal terms.

"Either way, volatility expectations just seem too low when the prospect of an escalation in the "trade wars" narrative looms," he adds.