Beware, the dollar could rise further

Despite a Federal Reserve rate cut, the dollar has gained considerable ground in the week following the US elections. Rising inflation expectations and the way Donald Trump is putting together his cabinet are stoking the fire under the currency.

The smoke has also cleared on the currency markets after the elections. It quickly became clear that the Republican Party would soon be in control of the White House, the Senate and the House of Representatives. This gives Donald Trump all the space he needs to implement his policies, without the Democrats being able to pull the handbrake. In response, the dollar has risen by almost 3% against the euro in a week. This revival is caused by economists adjusting their expectations for the coming years based on Trump's statements and plans. For the dollar exchange rate, it is especially important that measures such as import duties and tax cuts can stoke inflation.

Calculated interest rate
The rising inflation expectation has a much greater influence on the dollar exchange rate than the interest rate cut that the Federal Reserve implemented last Thursday. This interest rate move had been factored in by the currency world for a long time. Traders are now choosing a position for a policy rate that will fall much less sharply in the future. A few weeks ago, according to data tool CME Fedwatch, there was a 60% chance that the rate would be at or below 3,5% in October next year. That chance has now fallen to less than 7,5%. Instead of a rate drop of more than 1,5 percentage points, a decline of at most 1 percentage point is emerging.

Money flow to the US
In Europe, the German economy is still struggling, so the European Central Bank (ECB) is continuing on the path of interest rate cuts. In addition to the shifting American interest rate expectations, there are more things that are giving the dollar a boost. Economic growth will also be significantly higher next year than in the eurozone, for example. As a result, many European investors are choosing to put their money to work in the United States, so that a new flow of money to the American currency is initiated. Some parties are also already taking a position in the dollar in view of the uncertainty that will arise during a new trade war.

The Lighthizer tube
For example, the Financial Times already reported that Robert Lighthizer had already been approached by Trump to shape trade policy. During his previous term, for example, the import duties on Chinese goods and services were already Lighthizer's idea. It is obvious that currency markets will closely follow the way in which Trump forms his cabinet in the coming months. Because traders are also anticipating rising inflation, some parties are already coming up with the scenario in which a dollar will soon be worth the same as a euro. It is still a bit early, but it could well turn out that way during Trump's term.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.