The Trump Dollar Revisited
This is a joint post with Cole Frank, a research associate here at the Council on Foreign Relations.
The bond market sold off this week, with long-term interest rate rates rising in both Europe and the United States. But the catalyst for the bond market move was the possibility that the ECB might be closer to scaling back its stimulus than was previously thought, not the risk that the Fed might be tightening to offset the (potentially) inflationary impact of a significant easing of U.S. fiscal policy. Tax reform is still on the Republican agenda of course, but it isn't likely to have an impact on the overall U.S. fiscal stance until next year (assuming the Republican caucus can bridge still large differences on the nature of the needed reform to the corporate tax code ).
And, for now, the market still doesn’t seem to be expecting that Trump will carry through with his most draconian campaign rhetoric on trade. No doubt significant skirmishes will arise. On steel for example, where at least two different courses of action seem to be under serious consideration. But—at least right now—the proposed trade actions are focused on specific sectors. No 45 percent across the board tariffs. And, critically, the market still seems to expect that the Administration will renegotiate NAFTA rather than walk out of it.
That at least is how we would interpret the moves in the dollar over the last several months.
The dollar, on the BIS’s broad nominal U.S. dollar index, has more than reversed the 5 percent appreciation it experienced after Trump’s electoral victory last November. And, interestingly enough, the rebound in the Mexican peso has done more than anything else to generate this swing. After depreciating more than 18 percent post-election, the Mexican peso worked its way back. It is now about 3 percent stronger against the U.S. dollar that it was prior to the election.
The euro is also now a bit stronger against the dollar than in November. That in turn has made it much easier for China to keep the yuan more or less stable against the dollar.
China and Mexico matter. Together they are close to 35 percent of the BIS index, somewhat more than the combined weight of the eurozone and Canada.
At the end of the day, the dollar has a far larger impact on the overall trade balance and on jobs in the traded goods sector than any trade remedies (see Joe Gagnon of the Peterson Institute). As a result, the diminishing likelihood that the Trump administration will deliver a large fiscal expansion may end up doing more to help maintain manufacturing jobs than any high profile trade action. Had it been sustained, the rise in the broad dollar after Trump’s election was likely to lead to the loss of roughly 400,000 jobs in import- and export-competing sectors.
Of course, if you zoom out the dollar is still quite strong; indeed, too strong for the U.S. manufacturing sector (The IMF also thinks the dollar is stronger than warranted by the United States' external fundamentals, see this). Thanks to its appreciation in 2014 and early 2015, the broad nominal dollar, as measured by BIS, is up more than 23 percent since the end of 2012.
And the full impact of that rise almost certainly isn't yet in the trade data.