PA OPINION: Why the dollar bulls are mistaken

Added 15th November 2016

The dollar has rallied in recent days as investors believe stronger US GDP growth and Fed rate hikes will push the greenback up. But markets are ignoring the forces that are likely to drag the dollar down in the longer term.

PA OPINION: Why the dollar bulls are mistaken

Since Donald Trump’s surprise election last week, the dollar has risen some 2.4% against the euro and slightly less against the yen. The only major currency not to have lost value against the dollar since November 8th is pound sterling.

How to make sense of this? Amid the huge uncertainty surrounding president-elect Trump’s policy agenda, it seems that investors only believe what they want to hear. They seem to think the Republican-dominated House will force Trump to drop his anti-immigration and anti-trade rhetoric, leaving him to pursue only the part of his agenda that could actually boost the economy: lowering taxes, cutting regulation and increase investment spending, especially in infrastructure, even though the latter actually looks like a hoax: the policy plan on Trump’s website talks about a “deficit-neutral plan targeting substantial new infrastructure investments (…) providing maximum flexibility to the states”.

So even though the financial stimulus will likely not be as large as some expect, it would still boost GDP growth, push inflation higher and correspondingly lead to higher interest rates.

So far, so good, or isn’t it? Well, fiscal stimulus will result in a widening deficit. This will drive up the costs of financing US debt, and will significantly drive up treasury yields. Foreign investors, who hold almost half of US federal debt, will likely react to this by reducing their holdings, adding to dollar pressure. One could argue that investors simply have no choice but to own US debt because it’s the world’s de facto reserve currency, and government debt elsewhere looks even less attractive.

This is true, but the presence of ‘The Donald’ brings another factor into the equation, since the president-elect has a history of forcing his creditors into restructuring debt on very unfavourable terms. This could hardly boost investors’ enthusiasm for investing money in US treasuries…

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About Author

Tjibbe Hoekstra

Senior Reporter

Tjibbe joined Expert Investor as a senior reporter in March 2014. Before moving to London he worked as a financial news reporter for various news outlets in Amsterdam, including Reuters and ANP, the main news agency in the Netherlands. He also worked for Fondsnieuws, a website and magazine for finance professionals in the Netherlands. Tjibbe holds a MSc in Public Administration and a post-graduate diploma in Journalism.



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