President-elect Trump says he prefers a weaker US dollar (USD), but economists and investors think his proposed policies will have the opposite effect. Since his election victory, the greenback has been rising; on the day after the election, the USD rose the most it had in years against a basket of other major currencies. Investors and traders are busy revising their forecasts for the world’s dominant currency.
AUD lower, USD higher
Source: Shaw & Partners
Even though the value of the US dollar is largely set by domestic developments in the US, its dominance means its movements ripple across the globe. Further big movements in the currency may be around the corner as policies spoken about by Trump on the campaign trail are implemented – or not. It’s very hard to know. Key implications for markets include expectations that the new administration will cut taxes and deregulate, introduce more tariffs, attempt to further isolate China, and increase spending on defence.
These and other policies are likely to lead to higher deficits, which could mean higher inflation, and therefore act as a break on interest rate cuts by the US Federal Reserve (Fed). Those higher rates would make holding USD securities more attractive, providing a tailwind to the greenback.
A rising USD often comes hand in hand with a weakening global economic outlook. One reason for this is that during times of economic turmoil, investors tend to sell off their risky assets and move into “safe havens”, notably the USD and US Treasuries.
International Monetary Fund (IMF) research published in 2023 found that after one year, a 10% rise in the value of the USD decreases output in emerging economies by 1.9%. Rich countries are less affected but still see their output cut by 0.6%. According to the IMF paper, the negative effects of a strong USD tend to linger for two and half years for emerging economies, and for a year for rich countries.
Swings in the USD’s value affect the global economy in two ways:
- Trade.
- Finance.
More than 40% of global trade – most of it not involving the US – is invoiced in USD. Furthermore, it is estimated that the USD is on one side of 90% of all foreign exchange transactions. Almost all commodities (like oil, gold, iron ore, etc) are typically priced in USD.
A stronger greenback raises costs for importers, which reduces demand for goods from abroad and reduces overall trade volumes. Across much of Asia and Latin America, therefore, movements in the USD’s value matter more than how local currencies behave. One academic study found that a 1% rise in the value of the USD against all currencies predicts a 0.6% decline in trade between countries in the rest of the world, after controlling for other factors.
Of course, a stronger USD makes it cheaper for Americans to buy foreign goods and to travel abroad, but American companies that export products or services may become less competitive. Approximately 40% of the aggregate revenue of S&P 500 companies are exposed to non-US sources.
Source: TKer
As important as the trade effects of a rising US currency, the financial feedback is also significant. For countries and companies that have borrowed in USD but lack sources of USD revenue, a rising greenback increases their debt burden and boosts their interest costs. Higher interest rates in America, coupled with a rising USD, make investing in the rest of the world less attractive. Capital tends to flow out from emerging markets, forcing them to raise interest rates as well, tightening monetary conditions just when their economies may start to suffer from a general trade slowdown.
What about the relationship between a strong greenback and commodity prices?
Like a lot of economic relationships, it’s complicated! Furthermore, the relationship may be changing. There is a significant long-run relationship between the USD and the US terms of trade. In the past, when the US was a net commodity importer, higher commodity prices corresponded to lower US terms of trade figures and a weaker USD. But now that the US is a large commodity exporter (it is the largest oil producer in the world at present, and growing production), higher commodity prices raise the US terms of trade and strengthen the USD. “Commodity currency” effects for commodity-exporting small open economies (like Australia) will perhaps become correspondingly weaker.
After the pandemic, rising commodity prices went hand-in-hand with a strengthening USD. This was a contrast to the usual relationship between commodity prices and the USD, but perhaps this will become more common in the future. The shift from being a net oil importer to a net oil exporter means that higher commodity prices will now tend to raise the US terms of trade, rather than lowering them. Changes in the relationship between commodity prices and the USD will have implications for commodity exporters and importers alike.
Source: Yardeni Research
Whether a strong USD lasts remains to be seen. Donald Trump has complained that a strong greenback hurts domestic manufacturers and costs American jobs. But he cannot force the Fed to cut rates. And as long as rates stay fairly high, America’s currency will probably remain a refuge for many international investors.
