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Hardy’s Macro View: Rule #3 for the Trump 2.0 market era.
Summary: The third article in the series examines the anticipated weakening of the US dollar due to Trump's economic statecraft, which aims to reduce external imbalances and is less friendly to foreign capital, as partially covered in Rule #1. This shift may lead to reduced global reliance on US assets and a correction in concentrated US equity markets. Additionally, potential US recession risks from a fiscal hangover, tariff disruptions, and weak consumer sentiment could contribute to the dollar's decline, with a possibly significant drop in the USD.
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In this third instalment of the series on the Trump 2.0 market era, I delve into Rule #3: the US dollar risks a significant weakening in coming months, building on themes from the first two articles. In the first article, I discussed the volatility of US policy and its serious intent despite the sometimes chaotic back and forth of Trump’ style. Then, in the second article, I ran down the risks associated with the very concentrated US equity market, both from Trump’s policymaking, but also from the subject of this article – the risks to the US dollar. Now, let’s explore how all of these factors could lead to a significant shift in the global financial landscape, impacting the US dollar outlook, an important factor in global portfolio returns, which are heavily USD-weighted.
Chart: The USD Index
The USD dollar index is a broad measure of the US dollar that is heavily weighted toward the USD strength versus the Euro and the Japanese yen. It recently fell to more than three year lows below 99.0 on the turbulence of the Trump era, which is spooking foreign investor sentiment toward US-based assets, whether equities or US treasuries. Ongoing weakness this year and into early next year could take the US dollar as low as 90, the area of its lowest level in 2021 and for the last 10 years, save for a brief period back in 2018.
The US Dollar: A Shift in Global Dynamics
The US dollar has long been a pillar of global trade and finance, but the Trump 2.0 era is poised to challenge its dominance, or least take the edge off. As discussed in the first two articles, Trump's economic statecraft prioritises reducing external imbalances, which could lead to a decrease in the use of the US dollar in global trade and as a store of value in US assets. This shift is driven by the administration's general stance on trade, but also new worrying signs of a shift in how foreign capital may be treated, exemplified by the new House bill's provisions to possibly tax foreign investments.
Impact on Global Capital Flows
Historically, considerable global current account surpluses (from the US perspective, deficits) have been recycled into US assets, bolstering the dollar's strength. However, with Trump's policies potentially deterring foreign investment, sovereign wealth funds and large investors may seek to diversify away from excessive allocations to US markets and treasuries. This trend has already contributed to the significant rise in gold prices, as investors look for alternative stores of value.
Risks from US Equity Market Corrections
The concentrated nature of the US equity market poses another risk to the dollar. As highlighted in the second article on the US equity market’s rich valuation. Any major correction in US equities—whether due to a slowdown in the AI theme or retaliatory tax regimes from other countries—could reduce capital inflows into US markets. Such corrections would naturally lead to a weakening of the dollar as investors reassess their exposure to US assets.
Economic Headwinds and Recession Risks
The most pressing threat to the dollar's strength is the risk of a US recession. Despite avoiding major fiscal disruptions from the Elon Musk-led “DOGE” (Department of Government Efficiency), several factors could still weigh heavily on the economy:
- Fiscal Hangover: The fiscal impulse has weakened under trump as Biden front-loaded spending in the current fiscal year to bolster his election chances. This will constrain growth potential.
- Tariff Disruptions: Tariffs act as a tax on the economy and many tariffs are in effect now despite most tariffs being suspended for negotiations (for example on autos, on all Chinese imports, ect.). Any tax reduces overall demand and, as well, pre-emptive purchases ahead of tariff implementation earlier this year will cannibalise some future demand. The ongoing uncertainty surrounding tariff levels as companies have no idea where they land also hampers investment and hiring decisions.
- Weak Consumer Sentiment: Surveys like the University of Michigan sentiment survey indicate historically low consumer expectations, further dampening economic prospects.
- Labour Market Concerns: Early signs of a weakening job market, such as declines in the JOLTS jobs survey, and a post-pandemic high in the “Jobs Hard to Get” portion of the US Consumer Confidence survey in May suggest potential challenges ahead.
- Fragile Consumer Spending: Savings rates have collapsed below pre-pandemic levels, indicating vulnerability in consumer spending during downturns.
- Immigration Policies: Trump's closure of immigration could exacerbate labour shortages, impacting economic growth.
Forecasting the Dollar's Decline
Given these factors, the US dollar is likely to weaken, with the USD index potentially falling towards 90 (currently near 99), USDJPY dropping to 120-125, and EURUSD appreciating to 1.25 or higher over the next six to nine months. This shift reflects the broader economic and geopolitical changes underway in the Trump 2.0 era.
Conclusion
As we navigate this new landscape, investors must remain vigilant and adaptable. The weakening of the US dollar underscores the importance of understanding the interplay between policy, market dynamics, and global capital flows as well as asset valuations, so many of which are USD based. Before the recent USD weakness, the US portion of the MSCI World Index peaked well above 70%, the most in decades. In the Trump 2.0 era, we have to recognize how volatility across asset classes can impact portfolio returns and to keep a balanced perspective and carefully thought-out portfolio strategies that don’t put too many eggs in one basket.
Stay tuned for the final article in the series in the next week or two, where we will explore Rule #4 and its implications for investors and traders.