US Dollar Rally Over Unless Trump Delivers a Substantial Fiscal Boost

Analysts at Barclays have said the US Dollar’s long-term period of appreciation is at risk of dying a slow death unless Donald Trump can deliver a fiscal boost.

If correct this should add further weight to the case that the Pound to Dollar exchange rate is in the process of bottoming out having suffered hefty falls in the wake of the EU referendum of June 2016.

The call on the US currency comes as it struggles to make sustained headway against its rivals with it being the second-worst performing member of a group of the world’s ten largest currencies.

Foreign exchange markets were sold a dream by Donald Trump, and they have realised his tax and spending plans are likely to remain just that - a dream.

Granted, some movements on tax and spending will likely be delivered, but markets and analysts are now betting they will not be anything quite like those promised by Trump during his election campaign.

“US fiscal policy will be the single most important driver for the USD over the coming months. Without a substantial policy boost that includes tax reforms, we see the current multiyear USD rally as close to an end,” says analyst Aroop Chatterjee at Barclays in New York.

Beginning of the End

Chatterjee notes that the beginning of previous Dollar corrections has been accompanied by a decline in the relative marginal product of capital, although real rate differentials, relative output gaps, and changes in terms of trade, have also mattered.

Barclays have studied different scenarios for fiscal policy and model-based implications for the USD Real Effective Exchange Rate.

“Under our base case of a modest tax cut and our bear case of disappointment, the USD REER is likely near its top. The speed of decline is in line with past downturns in the bear case compared with a slower pace under our base,” says Chatterjee.

But, in their bull case, under reasonable assumptions, there is room for further USD appreciation towards the 1985 highs.

Even if Trump Delivers, it Might not Help USD

The view that perhaps this is the end of the cyclical Dollar rally is not an uncommon one amongst the analyst community.

The Dollar is probably peaking versus western European currencies says Kit Juckes, a foreign exchange analyst with Société Générale.

Whilst cutting taxes might stimulate short-term rates and therefore the Dollar the effect is likely to be short-lived.

For Société Générale the future direction of US interest rates is where the Dollar story lies.

The debate about monetary policy has shifted from whether or not there will be a June rate hike to what the Fed Funds ‘terminal rate’ will be.

Last month we reported that HSBC have cut their forecasts for the US Dollar on the assumption that the cyclical upturn in the currency was drawing to a close.

Again, much of the reason for the call centres on Donald Trump’s inability to deliver the kind of spending and tax plans he promised in his election campaign.

But HSBC’s Global Head of FX Strategy, David Bloom, goes a step forward saying that even if Trump delivers on his cuts they are not guaranteed to be positive for the Dollar.

The analyst notes:

“While the market is still waiting in anticipation of fiscal changes, we believe aggressive tax cuts if implemented could lead to an eventual USD switch from cyclically positive to structurally negative.

“Here, government debt, budget deficits and trade imbalances become the focus. So, at first, the fiscal boost is seen as USD positive on a cyclical basis; however, this fiscal boost could soon switch to structural worries about bigger deficits and become USD negative.”

So, if Bloom is correct, it is lose-lose for the Greenback.