What Can Trump Do to Keep the Dollar Down?

The US president will have a hard time keeping the Dollar down, says Capital Economics’ Jonathan Loynes in a recent note to clients of the advisory service.

In a play on the age-old theme that market forces will prevail regardless of interference from politicians and central bankers, Loynes says Trump is constrained in his ability to limit the currency’s appreciation.

“We think he will struggle to keep the dollar down,” said the economist on Good Friday, in response the Trump’s admission that he thought the US Dollar was getting too strong and that it was, “partly because people have confidence in me.”

The Dollar had dropped over half a cent on the previous day due to Trump’s comments although it was bouncing back strongly on Friday, coming off 1.2575 highs and rebounding to 1.2510 to the Pound.

One option for Trump is to weaken the Dollar by delaying his planned fiscal programme. The Dollar already fell after his failure to repeal the Affordable Care Act due to concerns Congress would stall Trump’s even more contentious infrastructure plans.

This might have suited Donald Trump if he wants to cap the greenback.

Another thing Trump can do, according to Loynes, is try to stuff the Federal Reserve full of monetary doves – that is, officials who prefer to set interest rates lower rather than higher – and he has already intimated he will consider re-nominating the dovish chairman of the Fed, Janet Yellen, however, this is unlikely to be sufficient in itself to preventing a rise in the exchange rate.

“Without a wholesale change in the Fed’s mandate, the effects of personnel matters are likely to be overwhelmed by the more fundamental drivers of policy. In short, we don’t expect Trump’s attempts to keep the dollar low to succeed for very long,” said Capital’s Loynes.

Trump cannot interfere with the economy that much, and Increasing US growth is likely to continue to put pressure on the Fed to raise interest rates which will keep the Dollar strong as higher interest rates attract foreign money.

“There are limits to the extent to which Trump can fight the economic cycle. While US growth may have underperformed in Q1, the recovery is still much more advanced than those of most of the US’ competitors and the upward pressure on underlying inflation pressures is correspondingly stronger. That, in turn, will keep the Fed on a path of steady policy tightening, while other central banks remain under little pressure to follow soon,” said Loynes.

Trump - Defender of Global Growth?

If anything is going to keep the Dollar down, in fact, it is, ironically, world growth, as this will pressure central bank’s in other countries to raise interest rates, thus closing the gap with the Fed, and reducing the Dollar’s relative attractiveness.

But it is not just that global growth will limit Dollar strength by raising interest rates globally, it may also help keep the Dollar down in other ways.

It will support another of Donald Trump’s pledged reforms – ostensibly put forward to improve Bank profitability – which is the relaxation of Dodd-Frank regulations limiting bank’s investment activities.

It has been argued by analysts at Morgan Stanley, that the ‘real’ reason for Trump wanting to relax Dodd-Frank is that it could1 be a useful mechanism for keeping the Dollar down because it will make it easier for banks to invest more overseas, which will increase Dollar selling.

On this point, one possibility highlighted by Loyne’s note could be significant in terms of US flows to Europe which is still lagging far behind the US and is seen by many as providing a ‘bargain basement’ for investors.

Loynes, notes how, “the euro-zone’s composite PMI index has surged above the US equivalent in the last few months, potentially pointing to a sharp rise in the euro against the dollar,” which underscores the latent potential in Europe.

A relaxation in US financial regulation combined with the factors above could set up a strong net flow of money form US banks into European investments, which could provide a considerable backdraft to the Euro versus the Dollar.

Nevertheless, coming back to Capital Economics, they remain orthodoxly bullish for the Dollar in the medium term, projecting parity for EUR/USD and 120 for USD/JPY.

“We maintain our forecasts for the currency to rise to parity against the euro and to 120 against the yen by the end of this year, before the prospects of slower US growth and tighter policy elsewhere start to weaken the currency again in the second half of 2018,” said Capital’s Jonathan Loynes.