In late 2015, most analysts forecast a stronger dollar in 2016. Not for the first time, most analysts were wrong. The greenback trod water, largely because the US Federal Reserve, originally expected to raise interest rates four times this year, has yet to shift them at all. But now it seems the dollar bull is back. The trade-weighted dollar, measured against a basket of major trading partners’ currencies, has surged to a 13-year high. The greenback has also reached an eight-year high against the Chinese renminbi and a 12-month peak against the euro.
The markets appear to have “fallen in love with Trumponomics”, says Hamish McRae on Independent.co.uk. The hope is that cuts in income tax and a huge reduction in corporation tax will juice growth. Easing financial and environmental regulations may also bolster corporate profits. Meanwhile, Trump plans a spending spree on infrastructure. All this implies more borrowing, so bond yields have climbed.
So the growth and long-term interest-rate outlook seem to have improved, making US assets more attractive for global investors and boosting the greenback. For instance, the gap between the German and the US ten-year bond yields is now over 2%, the highest since 1989. The Fed is widely expected to raise short-term rates again next month, which tends to push up long-term borrowing costs. The latest economic data, moreover, has been solid, with housing starts hitting a nine-year high and weekly jobless claims at a four-decade low, says Jamie Chisholm in the Financial Times. This reinforces the strong growth/higher rates story.
Dollar strength could endure for at least the next few months. The European Central Bank and the Bank of Japan are expected to keep monetary policy loose. They could even add more stimulus, making higher rates an even more distant prospect. Europe’s increasingly shaky political backdrop is another reason analysts are starting to hear talk of euro-dollar parity; the single currency is now buying $1.06. Commerzbank’s Ulrich Leutchmann sees scope for the trade-weighted dollar to gain another 7% by the end of 2017.
Nonetheless, a protracted dollar bull is hardly a done deal. Markets have tuned out another part of Trumponomics: the protectionist sabre-rattling. A trade war would damage growth, implying a weaker dollar, and high tariffs would fuel inflation, reducing real interest rates, which is the key for foreign investors. “The dollar’s fate,” concludes the FT, “will depend on which of the countervailing forces implied by [Trump’s] various views predominates.”