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NEW YORK, Nov. 7 (Reuters) The U.S. dollar is receiving attention due to Donald Trump’s impending return to the White House. If the currency’s surge continues, this could have significant effects on everything from emerging markets to domestic manufacturers.
One day after Trump was re-elected as president and Republicans gained control of the Senate while making gains in the House of Representatives, the U.S. currency recorded its largest one-day gain against its peers in eight years on Wednesday. The dollar is up 3.8% this year and is at its highest level in four months.
Whether or not investors think Trump will implement the tax cuts and tariffs that are central to his economic agenda could determine how much higher the dollar rises. Although those policies might spur growth, they run the risk of escalating inflation and maintaining the high level of interest rates in the United States relative to other nations. The dollar is more attractive to investors when interest rates are higher.
The president-elect occasionally complained about a rising dollar during his first term because he believed that it could harm American businesses.
Helen Given, associate director of trading at Monex USA, stated that “a Trump administration likely means more spending, a hotter economy, and high bars for international trade—all things that spell strength for the dollar.”
TRAJECTORY RATES
The path of interest rates is key to the dollar’s future prospects. After a 50-basis point rate cut in September to begin its most recent monetary easing cycle, the Fed is anticipated to announce a 25-basis-point cut at the end of this week’s two-day monetary policy meeting.
Earlier this year, the dollar was depreciated due to expectations of rate cuts.
However, the possibility of higher inflation may make policymakers cautious about overheating the economy by making too drastic rate cuts. According to LSEG’s calculations, traders reduced their bets on the Fed’s rate-cutting potential for next year to roughly 42 basis points on Wednesday, down from 62 basis points last month.
Paresh Upadhyaya, director of fixed-income and currency strategy at Amundi US, described the current state of currency markets as a “tectonic shift.” Investors are now required to consider trade tariffs and the effects they will have on the outlook for global growth, U.S. inflation, and the Fed’s response to them.
Trump might find it simpler to implement tax cuts and give Republicans more freedom to pursue their economic agenda if Republicans win both the White House and both chambers of Congress in a so-called red sweep scenario.
Even though Republicans were expected to hold a majority of at least 52–48 in the U.S. Senate, vote counting was still in progress, making it unclear who would ultimately control the lower house.
In a Red Sweep scenario, Brad Bechtel, global head of FX at Jefferies, thinks the dollar could rise another 5% and continue to rise in the upcoming months as more of Trump’s agenda is implemented.
Trump’s inauguration is scheduled for January 20.
Following Trump’s election victory in 2016, the dollar gained roughly 6% versus a basket of currencies in the first two months before losing those gains in the following months. Between February 2018 and February 2020, when Trump imposed tariffs on a number of nations, including China and Mexico, the dollar rose by roughly 13%.
TRIPLE IMPLICATIONS
A rising dollar could have a negative effect on the U.S. economy by lowering inflation and decreasing the competitiveness of American goods abroad. Furthermore, it could have an impact on the profits of multinational American companies that have to convert their foreign profits into US dollars.
According to a JPMorgan study, strategists at the bank estimate that every 2% increase in the trade-weighted dollar reduces the growth of S&P 500 earnings by 1%.
Trump may urge the Fed to lower interest rates or pressure U.S. trading partners to strengthen their own currencies if a rising dollar becomes a barrier to growth.
Trump may also use the Exchange Stabilisation Fund, which currently has roughly $215 billion and was established in the 1930s as a means of stabilising the exchange rate. Analysts question how successful such a measure would be in containing the dollar without a global effort or backing from the Fed, and Trump did not use the fund during his first term.
Wells Fargo analysts wrote in a report on Wednesday that “Trump’s preference for a weaker dollar would have to be accommodated by and in coordination with the Federal Reserve, which we view as unlikely.”
Given the dollar’s role as a linchpin of the global financial system, persistent strength in the U.S. currency could ripple out to other assets.
Emerging market nations, particularly those that have borrowed heavily in US dollars, may find a strong dollar especially unwelcome as it would make it more difficult for them to pay back their debts.
According to Bechtel of Jefferies, that might put pressure on central banks in those nations—as well as some developed nations like Japan—to raise interest rates in an attempt to protect their own currencies.
He predicted that he would “enter this new regime of currency war that used to flare up from time to time in the past.”
Because tariffs have the potential to lower trade volumes, disrupt supply chains, and raise costs for consumers and businesses, some investors think they may ultimately harm the US economy. All of that might lessen the likelihood of future dollar strength.
According to a Deutsche Bank study, if tariffs were imposed, the US GDP would drop by roughly a quarter of a point.
Karl Schamotta, chief market strategist at payments company Corpay, stated, “The truth is that a full flight protectionist agenda will ultimately rebound on the American economy and slow growth.”