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Donald's Dollar

 Donald's Dollar image

Donald's Dollar

7th March 2017

With Donald Trump in office, many are asking what this means for the seemingly all powerful USD. Trump himself has expressed concern about a strong dollar, and some commentators have proclaimed an end to ‘The Strong Dollar’ policy.

 

It is debatable whether America even has a strong dollar as a policy objective. It’s just the way things have turned out. The dollar is the world’s trading currency, and US Treasuries are the go to risk free asset – that means all roads tend to lead to a strong dollar. On top of that, a multi-year bull market in equities has also attracted flows to the currency.

 

Enter Mr. Trump, whose most important task is to generate economic growth within the country. If he gets that right, rates will likely move higher, and so will equity markets. Both of those should lead to a stronger dollar. And this is exactly what the market is anticipating and discounting.

 

However, this is not likely to be a one-way street: a strong dollar will have self-modifying effects. USD strength will slow GDP growth, and may, in fact, spur growth in Europe and emerging markets. And, increased growth elsewhere will slow the dollar’s rise. So, while the dollar may strengthen, it will be a gradual process.

 

The other factor that may slow the dollar’s rise will be the upcoming negotiations over tax cuts, the debt ceiling, and infrastructure spending. The Presidency and Congress must play a balancing act between spending cuts, tax cuts, new borrowing and somehow balancing the budget. Add to the fact that any anti-Trump legislators are bound to use this as an opportunity to take on the President, and we have a recipe for gridlock. If Congress becomes gridlocked and any form of stimulus is held back, then markets are probably priced for too much growth, and we will see the dollar giving up its recent gains.

 

The way these negotiations play out is likely to determine the direction of the dollar over the next six months. At a later stage the forces at work in other economies, specifically Europe and China, will also impact the dollar – but the dynamics at play in America will dominate for the next six months at least.

 

An ‘alternative’ scenario may unfold if the Trump administration attempt to weaken the dollar to make the economy more competitive. A weaker currency has much the same effect as import tariffs and makes exports more competitive. The problem is that controlling the level of a currency is often easier said than done and can have unintended consequences (though it’s doubtful that that would concern President Trump). It’s an unlikely scenario but one worth considering. Talking a currency down is also popular, but can have the opposite effect when the market senses that further strength is expected.

 

Making a call on where the dollar may be in December would be a gamble right now. However, by the end of March, the direction should be far clearer.

 

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