As 2017 began, the tone for the US dollar and financial markets seemed firmly set. Having already risen around 5 per cent since Donald Trump’s election victory — along with a rally in US equities that became known as the “Trump trade” — there seemed little reason why the greenback’s rise should not continue.
Mr Trump was promising tax cuts and infrastructure spending, together with business-friendly deregulation that investors hoped would give the US economy a short-term boost.
Things have changed. The dollar fell back in the new year, and on a trade-weighted basis has now retraced about half of its gains. It remains more or less within its trading range of two years. Equity prices, whose rally continued into 2017, have also fallen back recently. Some of these moves are undoubtedly driven by the fundamentals of growth and interest rate differentials. Although the Federal Reserve raised interest rates last week, the move was already priced in. If anything, investors were surprised by how dovish the Fed’s open market committee sounded about future rises. Moreover, signs of economic recoveries gathering momentum in the eurozone and Japan have fed speculation that the next move in monetary policy in both those economies would be to tighten.
Still, given the timing of the rally, which began with Mr Trump’s election, it seems very likely that the dollar was reacting at least partially to the potential for a fiscal and regulatory boost. If so, the value of the dollar over the next weeks and months will also incorporate a degree of political risk determined by the president’s ability to push policies through Congress, and the ability of the congressional Republicans to unite around policy ideas.
Although its immediate impact on economic growth may be small, this week’s debate on the replacement for Barack Obama’s healthcare legislation underlines Mr Trump’s struggle. Even if a new bill eventually passes, he is still hobbled by his own lack of knowledge of policy detail, an understaffed administration and a fractious Republican caucus, some of whom place conservative principles above party loyalty.
True, persuading Congress, particularly a Republican one, to agree stimulative tax cuts should be easier than getting them to enact technically difficult changes to a politically explosive issue like healthcare. But even here, the road ahead will be hard for Mr Trump. His desire for a cut in corporation tax has been snarled up in a wider debate about a border adjustment tax designed to penalise imports and boost exports, which has proved deeply controversial. There is unlikely to be a serious attempt at tax reform this year that might produce a strong fiscal boost.
All in all, continued moderation in the recent strength of the dollar would be something of a relief. Mr Trump has been threatening trading partners with remedial action for the crime of running trade surpluses with the US, and blaming China for gaining a competitive advantage through currency manipulation. Both accusations are wrong-headed, but it is as just as well if a stronger exchange rate does not inflame the issues further.
If recent weeks are a guide, the idea that the Trump administration is going to be a re-run of Ronald Reagan’s — fiscal stimulus and tightening monetary policy leading to a soaring dollar — seems overdone. Mr Trump has talked an expansionary game, but so far has lacked the political muscle or competence to push it through. His supporters may be disappointed. America’s trading partners, fearing a resumption of currency wars over competitive devaluation, are likely to be relieved.