Is the Dollar’s Current Rally Based on Promises that Can Be Kept?
The Dollar Index has reached 13-year highs and looks likely to continue rising. The main reasons for the rise are Donald Trump’s new economic policies, but how likely are they to become a reality?
Few investors saw the Dollar rising to its current dizzying heights on the back of a Trump presidential win.
In fact, the opposite was true, most analysts expected Dollar weakness following a Trump victory due to a probable delay in the Federal Reserve raising interest rates.
The main factor driving the currency higher appears to be a belief that Trump will stimulate the economy and put money into infrastructure spending, leading to higher inflation.
The Fed will then be forced to raise interest rates pushing the Dollar higher in the process.
This is based on promises made in Trump’s manifesto that he would spend 550 billion on building an infrastructure in the US which was “second to none”.
It has only been two weeks since his election and none of his policies have been enacted yet, and there is an argument that they will not be because of resistance from the Republican-controlled Congress and Senate, who contain members averse to government-backed stimulus.
Unicredit’s Chief Global Economist Erik Nielsen is skeptical about the ability of Trump to get much in the way of a stimulus package passed.
He suggests the market is pricing in too much stimulus.
“I’ll give this present market sentiment no more than 5%-10% chance that it’s right.
“Rather, a modest fiscal easing (tax cuts to corporates and probably individuals), de-regulation of some parts of energy production and some protectionist noise seem a much more likely outcome – which would mean that risky assets might give half their post-election gain back during the next 3-6 months.
“And I would happily ascribe a 20%-30% probability to a very messy presidency, dominated by conflict with Congress and others, completely clouding policy making within the next 6-9 months - with all the confusion that would cause in markets,” says Nielsen.
Democrats Supportive
This is not the view of some in Washington, however, especially house Democrats who are supportive of the President's plans.
““We can work together to quickly pass a robust infrastructure jobs bill,” said Nancy Pelosi, the House minority leader, in her own statement on the election results,” as reported by the The Atlantic’s Russel Burrman.
Neither are all Republicans averse to a stimulus drive.
“Conservatives outside of Congress are watching the talks warily, but in a sign of just how much Trump’s election has shaken up the political dynamic, they have not dismissed the idea of a big infrastructure bill out of hand,” said Burrman.
Indeed Marcia Hale, who presides over a bipartisan advocacy group called Building America’s Future, said “I wouldn’t say everybody’s supportive, but there’s been a big change in attitude. People now recognize we need to do something.”
The group counts amongst its members former Transportation Secretary Ray LaHood, a Republican former Democratic Pennsylvania Governor Ed Rendell, and ex-New York Mayor Michael Bloomberg.
Where divisions start to appear, however, is in the detail – “what do we need to do, and how are we going to pay for it?” Said Hale.
These details seem crucial as to whether the President will be able to get the majority to agree on his stimulus plans.
One idea proposed by his advisers is to use tax breaks on investment to sweeten the proposition for the private sector.
Another source of revenue, particularly appealing to house Republicans, appears to be from corporate repatriations of money stashed overseas to avoid tax.
Trump has discussed a one off low tax rate for repatriations as an incentive.
If repatriated cash were used to set up an infrastructure spending bank, for example, that would “sit well with Republicans,” rather than just running up more debt, said one Washington insider.
From an FX perspective, the Dollar would also benefit massively from repatriation, as a high proportion of the money stashed by corporates overseas is in foreign currencies which would need to be exchanged for Dollars.
Indeed, whether or not the infrastructure spending drive goes ahead may be immaterial as far as the Dollar is concerned, as repatriation alone is likely to be a supportive factor regardless of what is done with the money afterward.
Trade Tariffs
Another of Trump’s policies which is likely to be supportive of Dollar strength is his stance on trade.
Trump wants to put 45% on top of Chinese imports, for example, and this probably have the effect of reducing foreign imports.
This, in turn, will support the Dollar as it should help to ‘right’ the huge trade imbalance, in which the US currently imports far more than it exports.
The advantage of his trade policies is that he is likely to be able to impose them without requiring support from the legislative houses, as the President has more executive authority to impose trade regulations without the need for support from Congress.
The likelihood of the President's trade tariffs being implemented, therefore, is much greater than his stimulus policies.
And this is probably part of the reason why despite his skepticism regarding Trump's stimulus promises, Unicredit’s Nielsen is sure about one thing in his analysis: that the Dollar will continue rallying.
“The one big move I – with the benefit of hindsight – can see some logic in, is the dollar appreciation.
“Any of my two first scenarios, (ie stimulus voted through or not) and some part of the third and messy one (Trump presidency fraught with infighting), would probably support a strong dollar, particularly against vulnerable EM currencies, already down 6%-10%.
“And all underpinned by a Fed now on the move,” writes Nielsen.
