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Categorized | Currencies

Donald Trump and the dangerous allure of a strong dollar

Posted on November 25, 2016

Among the souvenirs still available from the US election campaign is a “2016 Trump Dollar”, a commemorative silver coin bearing the face of the president-elect on one side and “Vote Non Politician” on the other.

While the Trump Dollar costs $70, the value of the real currency has surged to the highest in 13 years against a basket of rivals.

For a man as brazenly self-confident as Mr Trump, a strong dollar might be welcomed, to be worn as “a badge of honour — a signal of global confidence in Trumpism”, said Alan Ruskin, a currency strategist at Deutsche Bank.

But is a muscular dollar in the interests of the US or, indeed, those of its next president?

The president-elect has unleashed an investor feeding frenzy, with the dollar index, a broad measure of the currency, up almost 5 per cent from its level shortly before polling day. As Americans tucked into their Thanksgiving dinners, the dollar’s surge seems to represent the first and clearest example of how investors have bought into Mr Trump’s mission to “Put America First”.

Firmer dollar a double-edged sword

However, before he has even taken up residency at the White House, Mr Trump is confronting a foreign exchange market that some fear has got ahead of itself. The pace of the dollar’s rise has reached levels that some analysts believe will force the new Republican administration to resort to that time-honoured tactic of talking down the world’s biggest reserve currency.

Mr Trump is certainly aware that a firmer dollar is a double-edged sword, telling CNBC in May that “while there are certain benefits, it sounds better to have a strong dollar than it actually is”.

Most investors’ reference point for considering the merits of a firm dollar is 1995, when then Treasury secretary Robert Rubin promoted the idea that “a strong dollar is in the US national interest” — a mantra repeated with varying degrees of emphasis by successors, including Jack Lew in June.

Certainly no one needs to talk up the dollar in the current climate. Many inter-related factors are driving the currency, and nearly all are anticipatory — a Republican controlled Congress voting through tax cuts and an infrastructure programme; the Federal Reserve upping the pace of a tightening cycle as inflation rises; Mr Trump following through on trade protectionism; the repatriation of corporate earnings boosting equities; and foreign policy becoming more hawkish.

US economy plays key role

Investors, though, tend to overlook one tangible reason for the dollar’s rise that predates the US election. “The strong dollar speaks to the strength of the US economy and rising price pressures before Trump’s stimulus,” said Marc Chandler at Brown Brothers Harriman. Indeed, the currency rose more than 4 per cent from its low for the year in May to early this month.

That raises the anxiety that had been keeping the dollar at bay for the first half of the year — concerns at the Federal Reserve about the negative feedback loop of a strong dollar on the health of the economy.

Janet Yellen, the Fed chair, and the president-elect are cut from different cloths but both have expressed concern about the impact of dollar strength on US companies — Mr Trump more graphically, by accusing China of weakening the renminbi to tilt the advantage its way.

Mr Trump “has talked more about the renminbi than he has about the dollar”, said Steven Englander, head of FX strategy at Citigroup.

The quandary for Mr Trump is this, said Mr Ruskin. A tilt to protectionism may help the trade balance by suppressing imports but “it would be damning” if an overly strong dollar ended up hurting exporters and boosting imports.

Talking down the dollar no easy task

Even if the New York billionaire maintains pressure on Beijing from the Oval office, he’s unlikely to have much success in talking down the dollar, if that was his intention.

For one thing, the Fed may be more relaxed about dollar strength than previously. Currency experts say further falls in the jobless rate and a rise in overall participation in the labour market should provide policymakers with enough room to keep raising rates even in the face of a robust currency.

There is, arguably, a tendency to exaggerate the influence of foreign exchange movements on the US economy. Mr Chandler points to research by the Bank of International Settlements and the International Monetary Fund which suggest the economy is less sensitive to FX moves. “There is no need for the Fed to react [to a stronger dollar],” he said.

Then there’s the risk that the debate over whether dollar-renminbi levels were being influenced by dollar strength or weakness in the Chinese currency would be messy and protracted, potentially turning the FX market into a battleground for US-China relations and upending US non-intervention exchange rate policy.

Furthermore, while Trumpism has triggered the post-election impulse for buying dollars, factors outside of the US are also coming into play. The currency’s rise, for example, against the euro is in part driven by concerns about Europe, illustrated by record lows in German two-year yields. “Both blades are moving,” Mr Chandler said.

The forces behind the dollar’s resurgence may make it harder for Mr Trump to influence its direction As Geoffrey Yu of UBS Wealth Management suggests, reversing or halting the appetite for dollars may be beyond even Mr Trump’s bravura temperament.

“If you sell him the story that the dollar is strong because money is flowing into the US in anticipation of his policies, it’s very hard for him to push back on it,” said Mr Yu.

Strong dollar set to persist

So Mr Trump may live with the strong dollar for two reasons. Fighting it looks impossible, and allowing it to symbolise Trumpism may be politically to his advantage. But that will not necessarily last.

A big fiscal stimulus push would “drive the dollar to the moon for a while, but would come with a severe hangover down the road”, warned Mr Englander.

The more likely Trump strategy would be to allow the dollar to rise, but to put in some subtle verbal signals “to check excessive strength”, said Mr Ruskin, judging the moment for intervention when the trade-weighted dollar was about 10 per cent above current levels.

Investors are still coming to terms with the speed and depth of the dollar rally and FX experts suggest it will take until the end of the first 100 days of the Trump presidency before a clearer idea of the dollar’s path comes into view.

“People weren’t ready for a strong dollar and higher US rates,” said Michael Metcalfe of State Street. “It will take a while for people to adjust to the reality.”

That applies equally to the next US president.