'Mexican Standoff’ Has Wider Political Implications and Could be Negative for the Dollar

Image © Shealah Craighead, The White House

- Deadlock over Mexican wall, bad for political risk

- Potential for further uncertainty to undermine USD

- Debt-ceiling deadline and Muller findings on horizon

The U.S. Dollar is at risk of depreciation due to increased political uncertainty in 2019, partly as a result of a more partisan political environment in Washington, says Derek Hallpanny, European head of global market research at MUFG.

Up until now, the U.S. Dollar had been fairly immune to political uncertainty but this could change in the year ahead when politics could come to the fore.

Hopes were high of a more bipartisan approach after the midterm elections in November, however, the increasingly heated and prolonged standoff between Democrats and Republicans over the Mexican border wall has seen good-will quickly evaporate.

“The implications of this going on longer and longer obviously reinforces partisan politics in Washington - the prospect of an infrastructure spending programme for example, where there was talk after the mid-terms of bipartisanship coming back into Washington...is pie in the sky dreaming in this type of environment,” says Hallpenny, “and from that perspective, the broader consequences of these divisions is certainly a negative for the U.S. Dollar.”

The ‘Mexican standoff’ is only the tip of the iceberg, says Hallpenny; several other - arguably more important - political events lie in the not-too-distant future which could cause even greater uncertainty for the Dollar.

One event is the March 1 deadline for the expiry of the U.S. debt-ceiling limit, at which point the U.S. government will essentially run out of funds, as it will not be able to borrow to fund its outgoings. This will lead it to have to seek a new extension from Congress, which is controlled by the Democrats.

The danger for USD is that Congress chooses not to rubber-stamp an extension without concessions, which could cause a standoff with the government and another government shutdown, only more widespread and worse than the current one.

The Dollar will probably weaken - not just on the uncertainty and slowdown in growth caused by the shut-down - but also due to a rise in excess liquidity, according to analysis from Nordea Bank.

Nordea argues that in the event of a prolonged standoff the U.S. Treasury will have to pump circa $350bn of emergency reserves into the real economy, causing a short-term Dollar liquidity glut, and weakening the Dollar. The effect will be heightened the longer the standoff, which judging from the Mexican example could be quite extended.

Another key political risk event on the horizon is the publication of the findings of the Muller probe into the President’s links with Russia, which is expected some time in February. If Muller uncovers a compromising connection (not expected or forecasted by MUFG) it could lead to calls of impeachment and that too would cause the sort of uncertainty which would probably weaken the Dollar.

These risks could lead to a negative political backdrop against a broader deteriorating “relative cyclical story” which could provide a perfect storm for the Dollar, says MUFG’s Hallpenny.

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