President-elect Donald Trump just slammed the dollar (NYSEARCA:UUP). The world has counted on a strong dollar as a safe haven, helping the U.S. bond and stock markets. A change of this perception would be a risk to the equity markets (NYSEARCA:SPY).
Trump told The Wall Street Journal:
"Our dollar is too strong."
To date, Trump has said that China is a currency manipulator, apparently referring to the fact that they keep lowering the yuan to the dollar.
This time, PE Trump focused on the other side of the dollar:yuan pair. Instead of saying the yuan is too weak, he said the dollar is too strong. That has different implications.
If a country's leader tries to talk down their own currency, it can be a warning sign of plans to step in and weaken the currency.
In fact, that is what Trump hinted to. The WSJ article was quoted as saying:
Mr. Trump said the U.S. might need to "get the dollar down."
It's clear Trump has complained that China was manipulating their own currency. But here, Trump threatens that the U.S. could take retaliatory measures. His quote above calls for pushing back directly in currency markets.
The WSJ article went on to say:
"The president does have the power to buy and sell foreign currency-called foreign-exchange intervention-to change the dollar's value, and can even call on the Fed to use its own resources in that effort. Such intervention is particularly powerful when used in concert with other nations. That is why presidential rhetoric can temporarily influence the dollar's value."
Can you say, "currency war."
Currency War Risk
If Trump encourages actions that materially change the path of the dollar, other countries could retaliate. China has already shot back in the war of words with Trump.
If the U.S. takes action to weaken its currency, other countries will respond. Currency wars hurt multi-national company earnings and have proven to be destabilizing to markets. Such comments are an initial step to such risks.
Dollar And Markets Go Together
Source: St Louis Fed
Above is the relationship of the dollar (in blue) versus markets (in red). The chart above shows annual returns dating back to 1975.
You can see that in most years, markets and the dollar moved together. They both probably fed on each other exchanging leadership over time.
A strong dollar encourages investment confidence in the U.S., driving markets higher.
If the next President is against a strong dollar, it pulls a historic support from markets.
Markets are starting to get used to surprise Trump comments. Since his victory, the president-elect has quickly moved defense stocks, drug stocks, oil, stock and bond markets up and down. The moves come after surprise comments from a person with power. That said, he has not even taken power yet.
The surprise nature of these comments, coming consistently, could erode market confidence. The reason is some level of discount needs to get priced in if there is a constant element of surprise, change and unknown.
The dollar is now in Trump's crosshairs. A move to a weaker dollar could have market implications. Historically, a strong dollar means a strong market. The move to "get the dollar down" would have far-reaching market risk implications.
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