It may be an opportunity for currency markets to play ‘bad cop’ on the US administration’s proposed tax hikes—removing their trade threats by boosting the dollar.
In recent decades, market protests have often involved so-called bondholders, creditors demanding higher rates of borrowing due to ill-advised government budgets and making programs unaffordable in the process.
But as Donald Trump’s protectionist trade proposals—including a 10% import tariff—
Much to the chagrin of the President-elect and his advisers, the dollar has already risen to two-year highs against the currencies of America’s biggest trading rivals, undercutting the competition Trump’s tax plans are meant to protect.
A rising dollar helps restore the pricing power of exporters selling to the United States by flatter selling their currencies—enabling them to keep dollar values low and maintain market share despite higher payments.
The euro’s nearly 7% depreciation in less than two months has taken the sting out of the 10% charge that has yet to be implemented. A 4% drop in the Chinese yuan over the same period is very modest given the proposed draconian tariffs against Beijing—but the way forward is also clear.
Circular logic
Market arguments to strengthen the dollar are based on the idea that Trump’s tariffs – when combined with US tax cuts and the deportation of migrant workers – will reduce confidence in the overseas economy, while US demand grows and still high inflation spreads.
And in that case, the Federal Reserve may not cut its policy rates too far from here while other central banks are forced to step on the accelerator.
This has two main implications: It reinforces a long-term trend towards the ‘choice’ of the US as the destination of choice for global investors and may open an already wide interest rate gap in favor of dollar holdings.
Deutsche Bank, for example, thinks that Fed rates will now not get below 4% this cycle while European Central Bank rates will drop as low as 1.5%. That would eventually leave a gap of 250 basis points between the two policy rates compared to current market prices of a maximum of 180bp.
And if the eventual policy combination of tariffs and tariffs is too aggressive, it sees the euro/dollar exchange rate fall below parity – more than 5% below current levels. China, the German bank figures, will also allow the yuan to weaken gradually in that situation.
The entire conference explains why some of Trump’s advisers seem to want to put political pressure on the Fed to adopt an easier monetary stance, even though Treasury Secretary-designate Scott Bessent has retracted campaign comments about undermining the central bank in the “shadow” of the Fed boss. .
But with the Fed’s resistance likely to be tough, the dollar is sticking to its script.
$20 trillion in flood investments
Although the textbooks suggest that a yawning US trade gap should drag the already overvalued dollar by 10%-20%, this deficit has been exacerbated in recent years by overseas investment towards US assets in special economic activity and the country’s big business.
And following Trump’s election, global investors seem even more convinced that US financial assets are the only game in town right now—causing another dollar gain.
The total stock of foreign investment in America — essentially foreign ownership of US goods — expanded by more than $20 billion over the past 20 years to $22.5 trillion by mid-year.
In context, that investment deficit is now nearly three-quarters of America’s annual GDP and closes a trillion-dollar trade gap.
There may be some reckoning ahead given these staggering numbers and frothy estimates. But currency markets have a tendency to push for extremes until they encounter a change.
Rather than boiling over, high prices may exaggerate the problem. Besides being a trick to get some deals, they may not even be worth the trouble.
The views expressed here are those of the author, a Reuters reporter
— Mike Dolan, Reuters
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