The how and why of the correlation between USD and politics

As USD continues to trade at its weakest levels since before the 2016 US election, it's striking to long-time market watchers how much political turmoil is affecting USD. Sure, a President could be impeached (or is being unfairly attacked, depending on your political persuasion), but what does that have to do with the market?
Quite a bit in fact.
The dollar is a safety currency. This means that investors treat it as stable and reliable because of the stability of the US economy. When investors lose confidence in it, other stable and widely used currencies such as the euro, yen and pound benefit.
So how will the current investigations into Trump, his administration and his campaign's ties to former Soviet bloc spies and gangsters affect the dollar?
  1. Lots of movement. The dollar will see even more short-term dips and peaks based on news. If it looks like things will get back to normal. dollar goes up. If it looks more certain there will be an impeachment, dollar goes down.
  2. A weakening dollar could get much weaker. Impeachment/mass protests/obvious corruption = symptoms of instability. If what happens is what looks like what will happen, USD should weaken.
  3. Don't forget about Europe! The EU dodged a bullet with Macron however the region is still engulfed in controversy surrounding immigration, austerity measures, and creeping populist/authoritarian movements. The odds of a mass exodus from the euro are much lower as long as France and Germany stay as they are, however a European equivalent of Trump could set off a chain reaction in which countries leave the euro. Even if there's only the appearance of this, investors will price this risk into the currency.
It's important to keep in mind that much of these political events have short-term effects on capital markets. The value of a currency in the long-term is going to be determined by more traditional factors like economic health of the home country and interest rates.
While it does little good in the short-term, smart investors and traders are going to pay much more attention to the underlying fundamentals of the European and American economies when planning out their FX strategy. Meanwhile, check Bloomberg if anything wild happens in Washington -- odds are you're going to either love or hate what you see.


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