Trump's victory boosts the confidence of dollar bulls; future trends depend on policy implementation

According to the Zhitong Finance APP, Trump's victory in the U.S. presidential election has made the U.S. dollar the focus of attention. On Wednesday, following Trump's win in the presidential election, the Republican Party gaining control of the Senate, and an advantage in the House of Representatives, the dollar index recorded its largest single-day increase in eight years, reaching its highest level in four months.

The continued rise of the dollar could have far-reaching effects across all sectors, from domestic manufacturers in the U.S. to emerging markets. How far the dollar can go may depend on whether investors believe Trump will implement policies of domestic tax cuts and external tariffs. While these policies could boost U.S. economic growth, they may also exacerbate domestic inflation, leading to the federal funds rate remaining elevated for a longer period and higher than rates in other economies—although higher rates would increase the dollar's attractiveness to investors.

Meanwhile, a strong dollar could harm the interests of U.S. companies with extensive global operations, which is one of the reasons Trump has repeatedly criticized dollar appreciation during his first term.

Helen Given, co-head of trading at Monex USA, stated, "The Trump administration could mean more spending, a hotter economy, and higher thresholds for international trade, all of which imply a strong dollar."

Interest Rate Trajectory

The trajectory of interest rates is key to the future outlook for the dollar. The Federal Reserve "stepped down" by cutting rates by 50 basis points in September, initiating a monetary easing cycle. The market expects the Fed to announce a 25 basis point cut on Thursday.

Earlier this year, expectations of Fed rate cuts helped weaken the dollar. However, after Trump's victory, the prospect of heightened inflation may raise concerns among policymakers that excessive rate cuts could lead to an overheating economy. Traders reduced their bets on the extent of Fed rate cuts next year from 62 basis points last month to about 42 basis points.

Paresh Upadhyaya, head of U.S. fixed income and foreign exchange strategy at Amundi, stated, "I think this is a structural shift in the foreign exchange market. Investors now have to consider trade tariffs and their impact on U.S. inflation prospects, global growth prospects, and how the Fed will respond."

Trump's imminent return to the White House, along with the Republican Party controlling both chambers of Congress, will make it easier for him to implement his policies and give Republicans more leeway on the economic agenda. Brad Bechtel, global head of foreign exchange at Jefferies, indicated that in the event of a "red wave," the dollar could rise another 5% and further increase in the coming months as Trump implements more of his economic agenda.

Ripple Effect

A stronger dollar could be a double-edged sword for the U.S. economy: on one hand, it may help curb domestic inflation, while on the other hand, it could harm the competitiveness of U.S. products overseas and put pressure on the profits of U.S. multinational companies that need to convert overseas profits into dollars. JPMorgan strategists noted that a study by the bank found that for every 2% increase in the dollar's trade-weighted index, the earnings growth of the S&P 500 index would decrease by 1%.

If dollar appreciation becomes a hindrance to economic growth, Trump may urge the Fed to cut rates or encourage U.S. trading partners to raise their local currency exchange rates. Trump could also utilize the foreign exchange stabilization fund, but analysts are skeptical about how effective such measures would be in controlling the dollar without efforts from other global economies or support from the Fed Wells Fargo analysts stated, "Trump's preference for a weak dollar must be supported by the Federal Reserve, and we believe this is unlikely."

Moreover, given the dollar's critical role in the global financial system, a continued strengthening of the dollar could impact other assets. A strong dollar may be particularly unwelcome in emerging markets, especially in countries that have borrowed heavily in dollars—an appreciation of the dollar will make it more difficult for them to repay dollar-denominated debts. Brad Bechtel noted that this could force the central banks of these countries, as well as some developed economies like Japan, to raise interest rates to defend their currencies.

However, some investors believe that Trump's tariff policies could ultimately harm the U.S. economy, as they would increase costs for businesses and consumers, disrupt supply chains, and reduce trade volumes. All these factors could diminish the likelihood of a stronger dollar in the future. A study by Deutsche Bank indicated that if Trump implements his proposed tariff policies, it could lead to a reduction of about 0.25 percentage points in U.S. Gross Domestic Product (GDP)