The impact of protectionism
While fiscal easing, deregulation and tax cuts were part of Trump’s electoral campaign, protectionist anti-trade and anti-immigration measures have a more prominent place in his ‘contract with the American voter’. Though it’s conceivable Trump made such promises only to garner support with blue collar workers, Trump and Congress may feel forced to implement at least some of his proposals to satisfy his voters. Protectionism and a decrease in supply to the labour market which would be the consequence of cuts in immigration will suppress GDP growth and possibly also foreign direct investment, and fuel inflation. This all would put further pressure on the dollar.
While dollar investors do not seem to discount the impact of possible protectionism, their emerging markets counterparts do: while the S&P 500 and the MSCI EM index correlated strongly over the three months or so, the pair has decoupled suddenly since election day (see graph below.
The dollar is already strong
Finally, the dollar has already strengthened materially over the past couple of years. Trump, and especially the Republicans who are now in control of both houses, have emphasised economic growth is their main priority. Since American companies are already struggling to remain competitive abroad at current exchange rates, Trump and the Fed will do everything to keep the dollar in check.
As Luca Paolini, chief investment officer at Pictet AM, concludes: “Rising inflation and a wider deficit could spell an end to dollar strength. According to our models, the greenback is already some 20% overvalued on a trade-weighted basis.”
That investors are wrong to bet on the dollar strengthening materially is not to say that the euro is a safe place to be though. Trump contagion is a very real risk for the continent, with a constitutional referendum in Italy due next month and all-important presidential elections in France in spring. Perhaps the yen, or pound sterling which is down 18% against the euro over the past 12 months despite a post-election rally, are your best bet.