If it wasn’t already, interest in the US presidential race is about to go up a notch.
Today’s presidential debate between Democrat Hillary Clinton and Republican Donald Trump, arriving at 11am on the east coast of Australia, is seen by many as an event that could either slam the door shut on a Trump presidency, reversing his recent ascendancy in the polls, or blow the race to the White House wide open.
While the outcome of the November 8 poll will not be known for six weeks, analysts around the world have been hypothesising over what a Trump presidency — currently seen as around a 35% probability — will mean for financial markets.
That’s exactly what Vivek Dhar, a mining and energy commodities analyst at the Commonwealth Bank, has done, specifically looking at what a Trump victory will mean for commodity markets.
In a note released on Monday, Dhar suggests that main impact of a Trump election victory on commodities will likely be felt through two main mechanisms: movements in the US dollar and real 10-year US bond yields, simply the nominal rate less inflation.
Here’s a snippet from the report that looks at the US dollar’s role on the likely impact on commodity markets:
The US dollar tends to rise in times of uncertainty, stemming from a flight to safety. Market expectations that Trump will implement policy that is largely inflationary will also likely boost the US dollar. A stronger US dollar will apply downward pressure on commodity prices, as US$ denominated assets become more expensive to non-US consumers. Oil price benchmarks, iron ore, thermal coal and copper are the most at risk of declining in response to a higher US dollar.
Writing earlier today, Richard Grace, chief currency strategist at the Commonwealth Bank, suggested that US dollar would strengthen by 10% over a 12-month period should Trump prevail.
And here’s the second major influence that a Trump victory would have on commodities, according to Dhar: movements in US 10-year real yields.
Long term real yields tend to fall during risk events like Brexit and a Trump victory as bonds are purchased on safe haven demand. We use long term US real yields as a proxy for safe haven demand – so a more negative correlation implies greater safe haven demand for that commodity. This relationship has proven a more consistent gauge of safe haven demand than the US dollar because of the additional negative effect the US dollar has on commodity prices. Gold and silver, as we would expect, benefit the most from safe haven demand flows. Meanwhile, base metals see muted safe haven demand.
This table from the Commonwealth Bank looks at the correlation between movements in the US dollar and real 10-year yields to specific commodity markets.
Should Trump win the election, Dhar suggests that the market reaction will be similar to that seen following the UK Brexit referendum held in late June, with the most significant volatility likely to hit immediate after the outcome is known.
“Part of the reason for the lack of a sustained price reaction following the Brexit decision was the extent of uncertainty. Even today, the path for Brexit remains murky. Consequently, other market forces became more important,” says Dhar.
“A similar situation will likely unfold if Trump wins.
“His policies run the real risk of being watered-down, delayed or even changed. As such, a significant degree of uncertainty will likely lead to a sharp price reaction on day one giving way to other market forces.”