Investors Need Trump to Leave the Dollar Alone
Donald Trump Jr. said recently that the only color his father sees is green. But dollar traders have seen mostly red since President Trump took office.
The greenback has fallen 11 percent against a group of other top currencies in the past year, with the latest drop coming this week after Treasury Secretary Steven Mnuchin stomped on it, suggesting that he would welcome an even weaker U.S. currency because it would benefit trade. Commerce Secretary Wilbur Ross echoed the comments before Trump tried to walk them back somewhat on Thursday. But Trump, too, has indicated in the past that he would like a weaker dollar.
While Trump and his team may want to cheer the dollar's drop, even in private, egging it on might be a mistake. A lower dollar does benefit large U.S. companies by making their goods cheaper to foreign companies and consumers, which should increase exports and sales. But the dollar's price relative to other currencies over time has been a pretty good indicator of increased inflation expectations, and that's been showing up recently. Inflation expectations embedded in 10-year inflation-protected Treasury bonds have risen from 1.7 percent in July to just more than 2 percent, which is the Federal Reserve's target. A further decline in the dollar might signal a bigger jump in inflation, and that could worry the Fed. It should also concern investors given other economic conditions.
"A weak U.S. dollar in a fully employed economy with rising inflation overtones combined with still very low yields and high P/E ratios is probably not a good cocktail for the financial markets," Jim Paulsen, a strategist at The Leuthold Group, wrote to clients this week.
In part the debate about whether the Trump administration should try to push down the dollar is similar to the one concerning taxes. Lower taxes can stimulate the economy, at least in the short run. (In the long run, there is an argument that the distributional effects of tax cuts, as they are usually structured, can be negative.) The question is really about timing. Cut taxes when the economy is already strong, and it could overheat, producing inflation and higher interest rates. But if you believe, as Trump seems to, that the economy is still weak and that the unemployment rate is actually much higher than it looks because many people have been left out of the workforce, then cutting taxes makes sense now.
The same is true of a lower dollar. A falling dollar when the economy is weak can be beneficial, boosting demand for U.S. goods abroad. But if the economy is already at or near maximum output, stoking demand abroad by lowering the dollar would cause prices to rise drastically. So even if you think the economy is weak enough to benefit from a tax cut, pulling on another lever of growth could be too much.
What's more, the Trump administration really doesn't need to put its thumb on the scale. The dollar is likely to continue to fall all on its own. Currencies are generally driven by the relative strength of countries' economic growth. And while the U.S. is growing, the global economy has been growing faster recently. Most economists, tax cuts aside, expect that to continue, which should continue to curb the dollar.
In fact, Trump should really want the dollar to stabilize if not rise slightly to buoy his favorite barometer of success, the stock market. A higher dollar could give the Fed cover to delay one of its planned rate increases, or at least hold to just the expected three. The real worry about the tax cuts is that they could be blunted by the Fed's campaign to lift interest rates. Low interest rates and lower taxes are the perfect hyperfuel for the market and more fodder for Trump's twitter megaphone.
That combination has propelled one of the longest bull runs in history and is a key reason the S&P 500 Index is trading at 23 times trailing earnings. Trump clearly wants the machine to keep humming. Rapidly rising interest rates or inflation or both could throw it out of whack. Pulling the dollar lever could do just that.
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