Dollar to drop as election cycle kicks in

ECONOMIC factors, not the political affiliation of the next US President, will likely determine dollar direction over the next few years. So what is the economic outlook for America post-election?

Let's look at the stock market first. Historically, US stock markets tend to post their strongest gains in the two years preceding an election. This is what we call the 'election cycle'.

To date, this term of office has broadly followed the 'election cycle' the first two years of George W Bush's term were characterised by falling stock prices and anaemic economic growth; whereas the last two years have seen the White House pursue growth at all costs.

Various stimuli, including tax cuts, increased spending (particularly on the military) and an engineered weaker dollar have all combined to boost US growth. US interest rates have also conveniently remained at emergency levels to support the White House's massive fiscal stimulus, and sure enough, the US economy is growing at an above-trend rate as the election nears.

Equities, however, have failed to respond in kind. Stock markets have under-performed in the US this year the Standard and Poor's 500 isn't even up by 1% year-to-date, against a 22% yearly gain in 2003. That's an ominous omen for the Bush camp facing into this election.

To compound the stock market's nervousness, the 'election cycle' suggests US economic growth will slow in the next two years. Interest rates also look set to rise from current emergency levels over the next two years.

Record oil prices (in nominal terms) will likely have a depressing effect on growth over the medium term. The US is nowhere near as reliant on oil as it was in the '70s, but rising fuel prices act as an effective tax on consumers' disposable income, which suggests that Americans will spend less next year. So a slowdown in US economic growth seems inevitable over the next year or two.

In a recent survey of American chief executives, the Business Roundtable (a US business lobby) found they expect US GDP growth of no more than 2.5% next year. Against anticipated GDP growth of 4.2% in 2004, that's a sharp downturn. If that's really what American business leaders believe, then the US labour market might well remain subdued for the next year or two.

The odds really are stacked against the dollar: history points to slower US growth next year the recurrence of the 'election cycle'. Monetary policy expectations point to slower US growth next year. Energy cost expectations point to slower growth next year.

Finally, subdued business confidence points to slower US growth next year. We're not predicting a recession, but a slowdown from the current cyclical peak in growth seems inevitable.

Then add to these factors America's near-record budget deficit, and its external imbalances, and it really is hard to make a case for dollar strength in the years ahead. So over the course of the next presidency we expect the dollar to weaken, as the familiar 'election cycle' repeats itself.

The views and opinions expressed in this article are those of the author and do not necessarily correspond with those of Ulster Bank or any other member of the RBS Group.