The recent shift in polling toward President Trump has sparked more conversations around so-called "Trump trades" emerging in financial markets. But how much of a Trump win is the actual market pricing in—beyond what online betting markets might suggest?
To address this question, Deutsche Bank's chief FX strategist, George Saravelos, shared insights, noting that despite the growing narrative around a Trump win, market pricing remains more restrained. Although Saravelos has previously analyzed a range of scenarios tied to the multiple uncertainties surrounding U.S. policy outcomes, he emphasizes a cautious stance in the current market.
For the purpose of this analysis, Saravelos defines "Trump pricing" as a scenario where the United States enacts an aggressive tariff policy, coupled with substantial domestic fiscal stimulus. This combination could counterbalance the adverse effects on U.S. growth while negatively impacting growth in other economies.
In the FX market, Saravelos points to his favored metric for assessing Trump-related risk, focusing on the dollar's risk premium over the interest rate differential. During the height of the 2018 trade war, the broad dollar appreciated around 10% above its rate signal, capturing the heightened risk premium. Currently, however, the dollar is roughly aligned with its rate guidance and has only recently begun to build any risk premium. For example, the EUR/USD rate, which fell from 1.12 to 1.09, primarily reflects shifts in Federal Reserve expectations following a stronger U.S. payroll report. Only the recent decline can be linked to rising expectations of a Trump election outcome. According to Saravelos, a full-scale trade war accompanied by U.S. fiscal stimulus could push EUR/USD close to parity.
Looking beyond FX, there's limited evidence of the market taking an aggressive stance. Within equities, a group of S&P 500 companies that are particularly sensitive to tariffs has been largely stable and has only recently shown underperformance. This movement aligns with recent polling changes but doesn't appear to reflect an outsized reaction.
On the central bank front, Saravelos offers a basic estimate for the European Central Bank's (ECB) potential terminal rates under an aggressive tariff regime. He suggests that, without tariffs, the ECB rate could approach 2% or higher, whereas a protectionist policy might reduce it to around 1% or less. If the election outcome were uncertain, a coin-toss scenario might suggest a market-implied rate around 1.50% for the ECB. Current pricing, at 1.7–1.8%, already suggests some caution. Similarly, the Fed-ECB rate differential currently aligns with estimates of the natural rate difference at 150 basis points. However, Saravelos indicates that a significant Republican victory could widen this gap to around 200 basis points or more, with a Fed rate at 4% and an ECB rate near 1%.
In conclusion, while Saravelos acknowledges a growing market probability for a Trump victory, he emphasizes that the degree to which this expectation is priced into the market remains moderate. Thus, while sentiment may be shifting, the market's response is measured rather than fully embracing a Trump victory as the expected outcome.
