- Bond markets are not convinced by Trump, but the dollar remains strong
- Higher interest rate expectations underpin the buck
- Trump’s tariff plans could stoke inflation but may reduce the US trade deficit and potentially support the currency
- A strong dollar is traditionally unhelpful for both emerging economies and commodity prices
“The US government bond market is far from convinced by the prospect of a second Trump presidency, and the stock market is wavering a little, but the US dollar continues to rise,” says AJ Bell investment director Russ Mould. “The DXY trade-weighted benchmark for the buck stands at its highest level since autumn 2022 and sustained strength in the greenback could pressure both emerging economies and commodity prices, at least if history is any guide.
Source: LSEG Refinitiv data
“There are three reasons why the dollar continues to make ground:
- First, inflation is sticky and the Federal Reserve’s apparent policy pivot in December, when chair Jay Powell noted ‘we are in a new phase,’ means markets now believe interest rates will come down more slowly than previously thought. The prospect of higher returns on cash (and US government bonds) could be attracting capital flows. According to the CME Fedwatch survey, markets are now pricing in one interest rate cut of one-quarter point in 2025, down from forecasts of four such moves just three months ago.
- Second, the US economy continues to defy the doubters and produce steady economic growth, at least as evidenced by the latest rounds of jobs and employment data. Again, this continues to persuade financial markets that interest rates may not need to come down much to keep US output on a healthy trajectory.
Source: US Federal Reserve, CME Fedwatch service
- Finally, president-elect Trump’s tariff policies are designed to reduce America’s trade deficit through reductions in imports and growth in domestic supply. The US has not run a trade surplus since 1975, according to the US Bureau of Economic Analysis, and Trump’s first administration made little or no dent in the annual trade deficit.
“If he succeeds in his second term, and America sells more than it buys, dollars will flow back to the USA, rather than out of it.
Source: FRED - St. Louis Federal Reserve database, US Bureau of Economic Analysis
“There are still plenty of ‘ifs,’ ‘buts’ and ‘maybes’ here.
“Rhetoric during his previous presidency suggested Trump preferred a weaker dollar and comments from vice president-elect J.D. Vance in the 2024 campaign also leaned toward a lower dollar as a potential boost to exports.
“In addition, Trump spent his first spell in the White House badgering the US Federal Reserve for interest rate cuts. Looser monetary policy could also weaken the dollar, at least if the Fed lowers headline borrowing costs either faster than expected, or faster than its global peers, or indeed at all, given the current market consensus of just the one quarter-point cut for 2025.
“Only time will tell, but if Trump does impose tariffs, the US trade deficit shrivels, and the dollar remains firm then there could be consequences.
“Commodity prices tend to struggle under a strong dollar, because they are generally priced in dollars and a higher greenback increases the cost of raw materials for non-dollar users.
Source: LSEG Refinitiv data
“Emerging markets also tend to struggle. This is because their dollar-denominated debts become heavier and more expensive to service and the MSCI Emerging Markets is starting to sag and give up the ground gained in the past year or so.
Source: LSEG Refinitiv data
“In short, a strong dollar is inherently disinflationary, even deflationary for the world.
“Markets do not seem concerned right now – if anything the increase in benchmark 10-year Treasury and gilt yields in the USA and UK smacks more of worries over inflation rather than disinflation or deflation – but this only increases the potential impact of such a surprise, given how investors are apparently positioning themselves for a completely different scenario.”
