Fasten your seatbelts for a wild dollar ride

The dollar is under pressure from Trump’s unpredictable tariff poker game and a political turnaround in Germany. The recent exchange rate development looks a lot like that of early 2017. If history repeats itself, the currency market is in for a wild ride.

In the fourth quarter, it seemed as if the dollar could only go one way: further up. The currency had the wind in its back from a well-performing American economy. A lot of capital flowed to Wall Street from abroad. In addition, the growing interest rate differential with Europe, among others, made it relatively attractive to hold assets in dollars. Moreover, the currency benefited considerably from the prospect that Donald Trump would shake up trade relations after taking office. The dollar is quite popular in uncertain times. Nevertheless, the currency has suddenly fallen by 5% since the end of February. What is the cause of this decline? And is this the start of a larger slide?

This is how Trump hurts the US economy
To start with the answer to the first question: there is a wide range of developments and events that lie behind the dollar decline. Trump's entire tariff poker game is increasingly making itself felt in the American economy. If companies will soon have to pay a lot more for products that contain materials or semi-finished products from, for example, Mexico, Canada or China, consumers will eventually be presented with the bill. The expected growth rate of the economy in the United States will also come under some pressure. This will give the American central bank more room to lower the interest rate, which will also have an unfavourable effect on the dollar.

Germany opens its wallet
In the meantime, there are also all sorts of things happening in Europe that are making the euro somewhat more attractive. First of all, of course, the enormous German investment plan. Our eastern neighbours are going to invest €500 billion in infrastructure, defence and energy in the coming years. On the one hand, this gives the broader European economy a boost. In addition, Germany is unexpectedly abandoning its traditionally very conservative budgetary policy. The interest on German government bonds jumped towards the level of American government loans. Due to the shrinking interest rate differential, it is suddenly a lot less obvious to hold assets in dollars instead of euros.

Will history repeat itself?
The question of whether the recent decline is the prelude to a larger slide is more difficult to answer. It is still doubtful whether the German stimulus package will also have an impact on the currency in the longer term. Another uncertain factor is the policy of the American central bank. It would be very strange if the Federal Reserve were to tinker with the policy rate tomorrow. But due to the cooling economy, there is a good chance that there will be more interest rate cuts this year than the one rate move that economists were still assuming until a month ago. The recent exchange rate development is very similar to that of early 2017. At that time, a small revival of the euro grew into a rally of almost 20%. There is no guarantee that history will repeat itself, but it promises to be a wild dollar ride in the coming period.

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.

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