King Dollar is not a one-way bullish trade in Trumpworld

Carlos Barria/Reuters

It is ironic that during Donald Trump’s campaign he repeatedly advocated a lower dollar to help boost US exports but Planet Forex then bid up the greenback to 2024 highs after he won the White House. A week after election day the US Dollar Index was above 106. 

The financial markets rightly believe that Trump’s policy blueprint to impose universal tariffs, intensify the trade war with China, deport millions of illegal migrants and use tax cuts and deregulation to stimulate economic growth is dollar bullish. 

Even a 25 basis point rate cut did not deter the bulls, since Jerome Powell’s Fed failed to give guidance on the pace and timing of future reductions. The Fed chairman even refused to rule out a rate rise at a future monetary conclave in his post-meeting press conference. 

This is the sixth weekly gain in the US Dollar Index as Wall Street prices in the impact of stronger US economic growth, inflation angst and now a decisive Trump win on a red wave. 

The biggest risk to Trump’s MAGA vision is the US budget deficit – a shocking 6.4 percent of GDP

In contrast, inflation in the eurozone is significantly lower than the European Central Bank’s 2 percent target. Political crises in Paris and Berlin are exacting a political risk premium on France’s OAT government debt’s yield spread above German Bunds. These are now at their highest since the euro sovereign debt crisis in 2012.

Since early October, hedge funds, asset managers and corporate treasurers have been accumulating long dollar positions against the euro, yen, Chinese yuan, and sterling. Emerging market currencies vulnerable to tariffs such as the Mexican peso, Vietnamese dong, Indian rupee and the Philippine peso are also being targeted. 

Risk reversals in the foreign exchange option market even suggest that the King Dollar trend could pressure the euro down to parity and the Chinese yuan to below 7.6, levels the world last witnessed in the pre-Lehman Stone Age.

Paradoxically, the King Dollar trend will be anathema to Trump’s policy agenda after he is sworn in as the 47th American President in January. The political, fiscal and economic storm clouds that could derail King Dollar next year are formidable. 

The biggest risk to Trump’s MAGA vision is the US budget deficit – now at $1.8 trillion or a shocking 6.4 percent of GDP.

It is ominous that the yield on the 10-year US Treasury note has risen 83 basis points seven weeks after the September Federal Open Market Committee jumbo rate cut, even though the Powell Fed has cut the overnight borrowing rate on bank excess reserves by a cumulative 75 basis points. 

Is this the opening shot by bond vigilantes who will impose risk premia on long-term US Treasury bond maturities to express their disgust at Uncle Sam’s fiscal insanity? If so, will the spike in US Treasury bond yields escalate into a global run on the US dollar next year?

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As the economist James Grant said, US Treasury bonds, the primary reserve asset of the world, no longer offer risk-free returns but saddle investors with return-free risk.

The smoke signals from Tokyo suggest that a weak Japanese government may respond to a plunge in the yen, rising JGB bond yields and deteriorating inflation risk by liquidating its trillion dollar war chest of US Treasury/agency holdings.

This will boost the yen, repress the yield on the 10-year JGB note, and reduce inflation risk in the Empire of the Rising Sun – but it will also pressure the US dollar.

China may also respond to punitive Trump tariffs by ordering its citizens and financial institutions to liquidate their US debt and equity holdings. The US is colloquially known in Mandarin as Meiguo or the Beautiful Country.

Since the Beautiful Country, in its infinite wisdom, has chosen to elect the Tariff King as its next president, an exodus of Chinese wealth from the US is a credible scenario for 2025.

A Republican Congress is likely to ratify Trump’s corporate tax cuts when they expire at the end of 2025. This could be a tipping point for the dollar bears as deeper tax cuts would take the US budget deficit to above 7 percent of GDP. That level sends any emerging market sovereign borrower into IMF purgatory. 

Note that this could happen at a time when steep tariffs on US imports are dampening growth in the consumer economy, already reeling from the impact of mass deportation.

Trump’s disdain for the political independence of the Federal Reserve is also dollar negative. The replacement of Jay Powell by a loyalist apparatchik would horrify the markets and empower the dollar bears, as would a political witch hunt in federal agencies and the abandonment of Ukraine to appease the Kremlin. Trump could even engineer a Plaza Accord 2.0 to dethrone King Dollar as Reagan did in 1985. 

King Dollar is not a one-way trade in Trumpworld.

Matein Khalid is the chief investment officer in the private office of Abdulla Saeed Al Naboodah and the CEO designate of a venture capital firm. He is also an adjunct professor of real estate investing and banking at the American University of Sharjah