US dollar gains momentum but inflation worries loom

By the OFX team | 12 November 2024 | 5 minute read

As the dust settles from the US election, the so-called “Trump trade” is in full swing, with stock indices surging, US yields rising on expectation of further debt under a Donald Trump presidency, bitcoin hitting a fresh record, and the US dollar gaining meaningfully in most pairs.

However, the longevity of the “Trump trade” is far from assured. Markets broadly expect a pro-growth environment to take shape, with accelerated deregulation as well as tax cuts for business – plus the vaunted trade tariffs on foreign products, particularly from China.

How much of the Trump policy platform will land is a question for 2025, but in trying to anticipate conditions, many commentators focus on the combination of increased spending and tax cuts, and the inevitable conclusion that these could in effect result in trying to put out the inflation fire with gasoline.

The President-elect is promising stronger economic growth, and that is part of the Trump trade into the greenback, but the corollary to this conviction is that the Federal Reserve might then have to consider holding rates at higher levels, so as to rein-in higher inflation – which, as it happens, Trump has promised to send in the opposite direction.

In fact, there are contradictions built into the Trump policy platform.

Immigration restrictions would likely reduce the supply of workers (especially in agriculture, construction, and service industries), potentially resulting in increased wages; businesses will pass these costs on to the consumer, potentially curtailing spending and growth.

The mooted tariffs will increase the costs of imports, which would also be inflationary for the US; and being at odds with trading partners would likely be bad for market sentiment, further boosting the US dollar.

The Federal Reserve, has just commenced its long-envisaged easing path, cutting interest rates in September for the first time in four years, and with a larger-than-expected 50-basis-point. The US central bank is expected to cut rates progressively over the next one to two years. That inflection has (so far) not hurt the US dollar at all – but there is plenty of risk attached to the US currency.

The fact is, the non-farm payroll report for October was a very poor print for the US economy – almost recessionary. The US economy added just 12,000 jobs in October, one-tenth of what the consensus of market economists estimated¹. The economy must be cut some slack, given that the October figure was affected by the temporary impacts from Hurricanes Helene and Milton and the ongoing strike by 33,000 Boeing employees, but the reported figure was dire: it was the smallest month-to-month employment gain in nearly four years².

Particularly worrying was the fact that the US economy lost 28,000 private jobs in October, the first net loss since December 2020³.

And, according to the federal government’s less-well-known employment survey – the household survey, which counts employed workers, not job numbers – the total number of employed workers in the US fell in October, month over month, by 368,000 workers⁴.

Newsletter writer, Adam Kobeissi, says full-time US private sector jobs have dropped by a “whopping” 1.5 million year-over-year, and that “such a drop in full-time private jobs has never been seen outside of recessions⁵.” In a similar vein, economic think tank The Mises Institute says: “In fact, year-over-year full-time job growth has now been negative for nine months in a row; for the past thirty years, that has only happened when the economy is in recession⁶.”

On such numbers, the Federal Reserve is virtually certain to keep lowering interest rates, as it did in its November meeting, by 25 basis points, and again in December.

So, we have the situation in which the Federal Reserve is committed to easing rates, and so is the new President’s rhetoric – but other elements of his program could work against that aim, by fanning the inflation fire.

Market sentiment definitely appears to favour the view that the second Trump Presidency and Republican majority will boost the US economy, leading to a stronger US dollar in the medium term; and the factors bolstering the dollar higher relative to other major currencies for much of the past decade largely still prevail. US economic growth exceeds growth rates in other major countries, and while the Fed has commenced easing, US interest rates sit higher than those in the rest of its peer group of the Group of 10 (G-10) countries, according to the Schwab Center for Financial Research⁷.

Currencies are always traded in pairs, and in its major couplings the USD also benefits from subdued outlooks for the counterpart currency: for example, this is true for the Euro and the pound (while the UK inflation picture looks better than that of the US, the economic growth environment does not). In Japan, a strong dollar is considered positive for Japanese exporters.

The sum total of these influences is likely to be near-term strength in the US dollar, with the ever-present caveat that nobody focuses too closely on the true US fiscal picture. The country’s indebtedness is not going to be improved anytime soon: both the Harris policy plan and the Trump one were assessed by the bi-partisan think tank The Committee for a Responsible Federal Budget as increasing the national debt, the former by US$3.95 trillion ($6 trillion) by 2035, while President Trump’s plan would increase the debt by US$7.75 trillion ($11.8 trillion)⁸.

In 2023, interest costs on the national debt totalled US$658 billion ($1 trillion) — surpassing most other components of the federal budget. The Congressional Budget Office (CBO) projects that interest costs in 2024 will reach US$892 billion ($1.4 trillion) — a jump of 36%from the previous year and following increases of 35% and 38%in each of the two years before that⁹.

America’s fiscal outlook is on an unsustainable path, which cannot go on forever. In any other country, there would probably have been a reckoning in the currency by now, to recognise this; but it seems that the greenback’s status as “top dog” protects it from this.

Nearly half of international payments were settled with the greenback last year, while almost 60% of all central banks’ foreign exchange reserves are denominated in dollars (down from 72% in 1999)¹⁰. While United States’ geopolitical rivals, most notably China, talk loudly of the need for alternative reserve currencies, the dollar continues to be the paramount currency. One day that might end; but very few currency traders would expect that to affect their strategies right now.

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