Fed Up With the Fed: What It Means for the U.S. Dollar

President Donald Trump has opened a new front in the cold currency war: He recently complained in an interview and on Twitter that the strong U.S. dollar puts the U.S. at a disadvantage and that China and the European Union have been manipulating their currencies and interest rates lower. Moreover, for the first time since taking office, the U.S. president openly criticized the Federal Reserve for tightening monetary policy, claiming that this “hurts all that we have done.” The greenback obliged and weakened against most currencies after his tweets on 20 July.

Could this mark the end of this year’s dollar appreciation and the beginning of a new phase of dollar weakness?

Supporting factors for the dollar

A new dollar downtrend is possible, as last year’s dollar depreciation and the recent knee-jerk reaction demonstrate, because currency markets seem to take verbal intervention from the U.S. administration seriously. An initial market move caused by, say, a series of presidential tweets could become a self-sustaining trend given that exchange rates are often influenced by fashions and momentum models.

However, we think further dollar appreciation in the coming months is more likely for many reasons.

1. Unlike early 2017, when comments by President Trump and U.S. Treasury Secretary Steven Mnuchin sent the dollar on a path lower, the greenback doesn’t look excessively strong right now. Despite a 6% appreciation since its February 2018 trough, the dollar index (DXY) remains 8% below its December 2016 peak.

2. Growth rates differ: Last year’s dollar depreciation was helped by the rest of the world playing growth catch-up with the U.S. This year, the U.S. is likely to keep growing strongly due to fiscal stimulus, while China’s economy has been slowing and growth in the eurozone has shown only tentative signs of stabilizing after a sharp slowdown, albeit from lofty levels, during the first half of this year.