Quick Bites | Go-Go Days for the Greenback

Donald Trump was inaugurated on 20 January, but for markets, his influence and power started even before 5 November last year. We’ve since seen 3 strong trends:

  1. A rising share market;
  2. A strong US dollar (USD); and
  3. Treasury yields returning from very low levels a few years ago to more “normal” yields.

In this quick bite (QB), we’ll focus on the strength of the greenback, the world’s undisputed reserve currency.

Because the USD is a safe haven, it rises in times of trouble, whether such troubles are of the economic or the geopolitical variety. It also gains when the US economy is booming. Its performance is generally unremarkable when the US is trundling along, but as we have noted many times in these QBs, the US is enjoying a period of “exceptionalism”, and this is showing up in the strength of its currency.

Before the US election outcome became apparent, the primary narrative in markets was about falling interest rates as central banks appeared to have finally gained the upper hand against inflation. Then came the Trump victory, and data suggesting that the US economy had more momentum than people had thought. Treasury yields rose, as did the USD.

Source: Bloomberg

The US dollar is strong against virtually all other currencies, including appreciating around 11% against the AUD since last September. The US Federal Reserve’s (Fed) measure of the real USD, considering different rates of inflation, puts it at its strongest level in 40 years.

Back in 1985, when Ronald Reagan was president and the USD was soaring, the Plaza Accord was signed – an agreement between the US, Japan, Germany, France, and the UK to devalue the USD. At that time, Japan was the arch-economic competitor and “currency manipulator” – not China as in more recent times. Could we see another Plaza Accord today? Probably not likely, although the Treasury Secretary to-be, Scott Bessent, has mentioned the possibility.

Source: Bloomberg

When Trump took office eight years ago, the long-term bull market for Treasury bonds (meaning yields moved steadily downward) was in full swing. That 40-year bull market is now well and truly over. As recent QBs have noted, US Treasury yields rising above 5% are potentially a share market valuation crusher and could cause a correction. But we are not there yet, and might not get there. In the meantime, fat, juicy Treasury yields of around 4.6% of 4.7% are attracting lots of global capital, pushing the greenback ever higher.

Source: Bloomberg

Markets are also anticipating the effect of tariffs. There is still great uncertainty about how much Trump’s tariff threats are bluff and bluster (or negotiating tactics), and how much will actually be imposed. Regardless, even moderate tariffs would represent a historic shift and would tend to support a rising USD.

Source: Barclays Research

Next point concerns inflation – which hasn’t dropped as fast as hoped, meaning that US cash rates won’t be dropping that much. Thus, the USD is being supported by higher rates at both the long end and the short end of the interest rate curve. 

Will the strong greenback hurt US earnings?

When the USD appreciates against other currencies, the value of sales generated abroad becomes less valuable in the US. This is why USD strength is considered a headwind for multinational American companies that do a lot of business overseas.

But the earnings of the S&P 500, which generates about 40% of sales offshore, are driven by more than just currency fluctuations, and it appears that there is not much convincing evidence that USD strength would be a major drag on earnings. The chart below shows that there is not much of a correlation between USD strength and changes in S&P 500 company earnings per share.

Source: Morgan Stanley Research