1. An America-first policy likely means a stronger dollar
An America-first stance, particularly with tariffs, could weaken demand for foreign currencies, strengthening the dollar against exporting countries like China and Mexico. While tariffs boost the dollar, they also come with risks, such as the potential for trade partner retaliation:
- China: Controls key raw materials, including rare earth metals, and could limit supply to U.S. semiconductor manufacturers.
- Mexico: Poised to push back if targeted, with the peso and U.S. stocks tied to Mexico already under pressure.
- Europe: Right-leaning governments are likely to support similar trade restrictions, amplifying volatility.
For a bit of history on dollar reactions to tariffs, in 2016, the trade-weighted dollar rose about 6% in the first two months after Trump's election victory but gave up those gains in subsequent months. The dollar went on to rally about 13% between February 2018 and February 2020 when Trump implemented tariffs against several countries, including China and Mexico. Protectionist measures, trade renegotiations, and tariffs are likely to drive more currency volatility.
But doesn’t Trump want a weaker dollar?
A strong dollar isn’t without risks, and Trump’s team knows it – he campaigned on wanting a weaker dollar. According to JPMorgan, every 2% rise in the trade-weighted dollar can cut S&P 500 earnings growth by 1%. If tariffs and a strong dollar start dragging on the U.S. economy, Trump could turn to the Exchange Stabilization Fund. Created in the 1930s to stabilize exchange rates, the fund has around $215 billion. This is just a drop in the bucket compared to total currency in circulation, but its use could still send a strong signal and spark currency volatility.
2. Higher U.S. rates and growth will continue to draw foreign capital
Investors are expecting Trump’s tariffs, tax cuts, and deregulation to fuel economic growth, increase inflation, and potentially slow Fed rate cuts. The U.S. dollar is strengthening as solid economic growth outpaces other major economies, drawing investor confidence. Higher U.S. interest rates compared to global peers are also attracting foreign capital, boosting demand for the dollar.
The October inflation report showed core CPI at 0.3% month-on-month – still uncomfortably high, even as the Fed downplays shelter price concerns. We still expect the Fed to follow through with one last rate cut in 2024 next month, but 2025 plans remain uncertain. We expect updated economic projections next month show the Fed trimming expectations from the four cuts currently projected for next year to two. This is also likely to move yields and the dollar higher.
Don’t forget: There is currently no viable alternative to the U.S. dollar as the global reserve currency. The euro, Chinese yuan, and Japanese yen lack the liquidity, trust, and institutional backing necessary to replace the USD on a global scale, which reinforces demand for USD assets.
Portfolio strategy
America-first policies and strong U.S. growth are likely to keep both equities and the dollar supported in the near term, making a tough case for international investments on a relative basis. That said, there is still a structural case to be made for international exposure, including geographic diversification potential against geopolitical events. And, while ex-U.S. markets have lagged in growth terms, they’re ahead of the curve in the rate cutting cycle. From here, rate cuts and easing inflation abroad could support recovery. Given near-term dollar strength, we recommend maintaining a full or partial currency hedge on non-U.S. exposure.
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