By many measures, conditions appear ripe for a dollar rally. U.S. stocks are surging, the Federal Reserve appears poised to continue raising interest rates, and the pro-business Trump administration is pushing plans for greater infrastructure spending and tax cuts which are widely expected to produce faster economic growth.
From election day Nov. 8 through the end of 2016, the 4.4% gain in the dollar index nearly matched the 4.6% rise in the Standard & Poor’s 500. Since then, the S&P has climbed another 6% while the greenback has slumped, dropping 1.8%.
One unexpected weight on the currency is that conditions in Europe and the U.K. have been surprisingly buoyant , allowing the European Central Bank and the Bank of England to consider monetary policy that’s less easy than expected, boosting the attraction of the euro and the pound against the dollar.
But the dollar, which often serves as a barometer of broader economic conditions, is also sending some troubling signals. Its weakness indicates the currency market is concerned that measures that Trump and Congressional Republicans plan to use to fund tax cuts are going to be more difficult to enact than stocks are currently pricing in, and that their proposals may not work as well as expected.
Should Trump’s policies not work as expected, gains in assets that have appreciated could be in jeopardy. The big concern would be for stocks where, Al-Hussainy notes, the stimulative impact "got baked into the equity market very quickly."
The American Health Care Act being pushed by Trump and House Speaker Paul Ryan is taking up a prohibitive amount of energy and attention, and may not pass, while House Republican plan for a border-adjustment tax —a key compenent of tax cuts plans, which would impose a 20% tax on imports while eschewing levies on exports —appears decreasingly likely to pass in a format that will produce the revenue needed to fund corporate tax cuts.
"The less likely the border adjustment is to getting passed, the smaller the corporate tax cut," Al-Hussainy said. "The border tax adjustment is not getting enough traction, and that was supposed to account for about half of the shortfall" in revenue produced by lowering the top corporate rate to 20% from 35%.
Should the tax pass, it may not raise as much money as House Republicans have claimed, as it relies on forecasts of unsustainably large U.S. trade deficits, according to a draft paper by economist Brad Setser of the Council on Foreign Relations and NYU Law professor David Kamin.
"Realistic projections of revenue from a border adjustment should show that revenue falling considerably and, possibly, entirely disappearing over the long-term," Setser wrote in a blog post March 17.
The health care bill Trump and Ryan are supporting, which the Congressional Budget Office forecasts would produce $337 billion in savings over the next 10 years, is in danger of not passing. Conservative Republicans argue the cuts don’t go deep enough, while party moderates remain concerned about CBO forecasts that passage would lead to 24 million fewer Americans having health insurance by 2027.
Any ramp up in infrastructure spending is now priced in for next year, while changes in the corporate tax code, which are key to the stock market’s ascent, aren’t expected until late this year.
And there are other unresolved issues within the U.S. economy that have been largely ignored amid the enthusiasm of the post-election stock rally. "I still see a lot of disinflationary secular influences that aren’t going away," said Jack McIntyre of Brandy Global Investments.
McIntyre points to the demographic challenge of an aging population, a manufacturing base that’s increasingly displacing workers in a turn toward automation and a daunting amount of debt piling up on the balance sheets of corporations and the U.S. government alike. As a result, McIntyre, who invests in global bonds, has reduced his exposure to the dollar to the smallest in the past 10 years.
"The equity market has certainly enjoyed the Trump effect, and that’s absolutely crucial to its rally," said Fabian Eliasson, a currency trader with Mizuho Securities. "The dollar is taking in a lot of other factors."