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Shaun Osborne Managing Director & Chief Currency Strategist |
President Donald Trump has inherited a strengthening domestic economy, rising US interest rates and a strong dollar and will benefit from a broader improvement in global economic growth trends. At this stage, no one can be sure exactly what the president can do, or how quickly his policy initiatives will progress through Congress. But we think it is reasonable to assume that key policy themes of the new administration – boosting US growth, repairing the US trade imbalance, creating jobs, lifting pay, deregulation, fiscal spending and tax reform – will be supportive of a strong or strengthening dollar in the short term to medium term at least.
However, investors are rightly wondering if the dollar’s value is a problem for an administration that is keenly focused on trade and competition issues. So far, the Trump team’s comments on the currency have been limited. The president himself remarked just before the inauguration that the dollar was “too strong” but those remarks to the Wall Street Journal were made in the context of the currency's value against the Chinese renminbi, rather than its broader level. During his confirmation hearings, the Treasury secretary nominee, Steven Mnuchin, remarked that he would pursue policies to keep the dollar strong and create and protect US jobs, but also said that the US currency was “very, very strong” – suggesting some unease with its recent appreciation.
Treasury secretary Robert Rubin first remarked that a strong dollar was in the US’s best interest in the mid-1990s, introducing what was to become known as the “strong-dollar mantra”. It became “required speaking” for Treasury secretaries subsequently, although it was deployed with varying degrees of enthusiasm. In practice, however, the US Treasury has historically done little or nothing to promote a strong-dollar policy directly because a concurrent and key tenet of G-7 FX policy has been the promotion of market-determined exchanged rates.
Even if the US Treasury has adhered to a strong-dollar policy to a greater or lesser extent, the US currency’s value has effectively risen and fallen with the underlying health of the US economy over the past 30 years. The relative strength of the US economy accounts for much of the dollar’s broader rise in the past five years in particular. Gains leave the dollar’s trade-weighted index looking strong certainly, but the index remains nearly 10% below the 2000 peak value and well below levels in the 1980s. By this metric, the dollar is firm, but not exceptionally so. We think the recent appreciation in the dollar versus its major currency peers is largely justified by underlying fundamentals.
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It remains to be seen how dollar policy is verbalized in the next few weeks and months, but it cannot have eluded the new administration that there are some obvious, potentially dollar-positive consequences of its policy platform. Stronger growth, looser fiscal policy and a clear, late-year surge in business and consumer confidence, suggesting that the Trump win has unleashed a broader rise in “animal spirits” across the economy, might entail the Federal Reserve lifting interest rates a little more quickly than markets are expecting currently, for example. Tax reform involving large-scale repatriation of retained US corporate earnings held overseas would likely boost US capital markets broadly and could lift the US dollar. “Border adjustment” taxes that promote exports and penalize imports might also have positive implications for the dollar.
If policymakers come to view a strong dollar as a real issue, there are only a few options in the traditional playbook to counter the problem. The Treasury could verbally intervene in the market – that is to say talk the dollar lower directly; policymakers could openly lobby other countries to lift their own “undervalued” currencies (essentially the same thing but without mentioning the dollar); it could direct the Federal Reserve to intervene directly in the market. We view the last option as unlikely as the Fed has generally refrained from direct and unilateral intervention in the dollar since the 1990s.
We think that a multilateral approach to managing a strong dollar is even less likely to develop as few developed economies are in a strong enough position fundamentally to support significant gains in their own currencies. G7 economies have generally taken a hands-off approach to currency issues in recent years, with the exception of cooperatively providing liquidity for market-smoothing purposes in periods of heightened volatility (such as the Japanese earthquake in 2011).
We expect the focus on pro-growth policies to confer strength on the dollar through the early months of the Trump administration at least. But gains might be tempered if the rising US economic tide lifts other boats and prompts central banks in Europe and Asia to become less accommodative sooner than markets currently expect. Investors might also fret at the prospect of significant increases in the US budget deficit or trade frictions that boost geopolitical risks.
The Trump presidency is expected to pursue pro-growth policies and might leverage fiscal policy and deregulation to achieve its goals. The president’s ambition is to “make America great again” and it seems unlikely that this goal can be realized without making the dollar strong, or stronger, as well.