Marshall Gittler Head of Investment Research, FXPRIMUS
Marshall Gittler Head of Investment Research, FXPRIMUS

Outlook for the dollar: monetary policy vs trade policy

So far this year, the monetary policy divergence theme has pushed the dollar higher, but can this theme continue? A lot depends on what if anything the Trump administration does about trade.

At the time of writing, the US is certainly the only major country where the market is expecting higher interest rates any time soon. The market doesn’t expect the ECB to start hiking rates until Nov. 2018 and Britain, the month after. As for Japan…well, they’ve kept rates near zero now for over 20 years. As defl ator fears subside and infl ation expectations rise, that means real interest rates are falling in all these countries while they remain unchanged or even rise in the US. It’s this growing gap that’s pushing USD higher.

At the same time, Trump has made narrowing the US trade defi cit one of the main goals of his administration. If he can do that by simply causing US manufacturing to grow faster than in other countries, it could even cause the dollar to strengthen further. The switch to a border adjustment tax (BAT) would also cause the USD to strengthen, according to many economists. But the path he’s chosen so far has been confrontation: criticizing other countries for their trade surpluses and for “currency manipulation” and threatening to rip up trade agreements and raise US tariffs on imported products. That raises the prospect of a trade war, and trade wars are rarely benefi cial for the dollar. For example, the last time the US engaged in such behavior, when President Bush imposed tariffs on imported steel from March 2002 to December 2003, the dollar fell 23% as determined by its trade-weighted value against the US’ major trading partners.

In short, while monetary policy is important in determining the outlook for the dollar this year, I think trade policy could be equally important.