The consensus on a strong dollar may be overconfident


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The writer is the author of ‘Two Hundred Years of Confusion Through: The Surprising Story of the British Economy’

A common thread running through the 2025 year-ahead outlooks from banks and asset managers is a near-consensus view that the dollar will strengthen further in the future. which is 12 months. As with everything else on the incoming Trump administration’s agenda, talk about the value of the greenback is sometimes contradictory.

Donald Trump himself, along with many of his top trade policy advisers, has long argued that a strong dollar makes American exports expensive, encourages imports and costs the American manufacturing jobs. Others appointed to key jobs, however, such as Scott Bessent, who was nominated for the position of Treasury Secretary, publicly took a more traditional stance and supported a strong dollar.

Whatever the new administration wants, markets seem reasonably certain that the result will be a stronger dollar rather than a weaker one. The dollar has risen around 8 percent since late September when investors began to price in an increased likelihood of a Trump victory in November. A stronger dollar has been a key part of the Trump trade that has gripped Wall Street over the past year. In general, the Trump trade is an assumption that the new president will follow through on all aspects of his agenda that the markets agree with, while his broader party is restrained from doing anything they don’t like very much. .

Tax cuts and deregulation will boost earnings and equity market returns while the resulting higher deficits will be bad, but not bad, for US Treasuries. Markets expected the yield of American government bonds to rise in relation to an anti-Trump counterfactual but actually thought that the increase would not be enough to destroy the stock market. The rising interest rate differential in other advanced economies however, by the logic of the Trump trade, is enough to push the dollar higher. The threat of higher tariffs, which would result in fewer dollars leaving America, has increased the dollar’s strength since November.

The line chart of the US Dollar index showing the rise of the Dollar on expectations of Trump advancing his agenda

The consensus view, then, is that the dollar will remain strong even if the new president occasionally takes to social media to moan loudly about it. There are, however, at least three reasons to worry that this consensus is complacent.

Tariffs are the first. Economic theory suggests that in the short term new tariffs can actually lead to a strengthening of the currency. The currency of the trading partner subject to the new restrictions often depreciates to offset, at least partially, the cost of the tariffs. This was the widespread case of China’s renminbi in 2018-19. But in the longer run tariffs are associated with fewer imports and exports and an overall weaker economy. That weakness eventually leads to lower interest rates and therefore a weaker currency. Tariffs may give the dollar a short-term fillip but weaken it in the medium to longer run.

Second, it’s worth taking seriously the idea that when Trump says he wants a weak dollar, he really means it. The threat of higher tariffs on America’s major trading partners could prove to be just an opening gambit in an attempt to fence off trading partners in some form of multilateral agreement to lower tariffs. in dollars. There is little doubt that the author of The Art of the Deal would not be happy to host a summit at Mar-a-Lago to handle the negotiations. Of course, the mechanics of such an agreement would prove tricky. The Plaza Accord of 1985, in which the finance ministers of the US, UK, West Germany, France and Japan met to discuss international payments, is sometimes held up as a model. But the world economy is a very different place today. The five participants 40 years ago represented around 45 percent of global GDP, in purchasing power parity, between them compared to more than 25 percent today.

Other major threats to the value of the dollar appear outside the traditional realm of economic policy. work of economists Barry EichengreenArnaud Mehl and Livia Chitu in 2017 examine the geopolitical foundations of international currency values. In general, countries have a greater share of their monetary reserves in a country that provides them with a security guarantee. By this argument the US providing security to its allies helps to control the value of the dollar and keep US borrowing costs lower than they would otherwise be. If security guarantees begin to be broken, then the dollar’s share of international reserves may begin to fall, which will provide an additional wind.

The dollar has had a strong run since September but many of the views behind those gains may prove to be wishful thinking.



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