U.S. Dollar Hovers Near One-Month High Despite Political Risks

The U.S. dollar rose against a basket of other major currencies on Friday, as optimism about a stronger domestic economy outweighed political risks concerning the Trump White House.

The dollar index, a weighted average of the greenback against a basket of six other major currencies, rose 0.5% to 100.95 on February 17. The index reached more than one-month highs earlier in the week after Federal Reserve Chairwoman Janet Yellen signaled that U.S. interest rates would continue to rise gradually throughout the year.

Higher interest rates make the dollar a more attractive bet for yield-seeking investors. Following its December policy meeting, the Federal Reserve said it expects interest rates to rise three times in 2017[1] – a vote of confidence to an economy that has faced significant obstacles since the financial crisis. However, investors shouldn’t expect the dollar to react much at all to subsequent policy moves by the Fed, since the currency has already gained over 20% since mid-2014. Those gains were largely tied to expectations the Fed would slowly normalize monetary policy.

The dollar has strung together an impressive rebound since the end of January, including a ten-day winning streak through February 14. Prior to that, the greenback was trading at three-month lows amid tough trade rhetoric from U.S. President Donald Trump. Prior to his inauguration on January 20, Trump told The Wall Street Journal he thought the dollar was “too strong,” especially in relation to the Chinese yuan.[2]

Trump would further erode confidence in the dollar by signing executive orders to curb immigration and reshape U.S. trade policy. With the stroke of a pen, the President formally withdrew the U.S. from the Trans-Pacific Partnership (TPP), a bilateral trade agreement involving 12 countries. Trump also signed an order calling for the immediate review of the North American Free Trade Agreement (NAFTA), which has governed bilateral trade between the U.S., Canada and Mexico since 1994.

Although not explicitly stated, the Trump administration clearly favors a weaker dollar. Within the context of global trade, a weaker currency makes a country’s exports cheaper to foreign buyers. This was most recently displayed in Japan, where a weaker yen helped the economy avoid contraction in the fourth quarter. Japanese exports rose 2.6% in October-December, the fastest in two years.[3] The economy expanded 0.2% as a result.

The dollar strengthened nearly 15% against the Japanese currency in the fourth quarter, reaching a high of 118 yen.

Despite Trump’s clear opposition to a strong dollar, the U.S. currency is expected to remain strong as the Fed continues to diverge from other central banks on monetary policy. Central banks in Europe, Japan, Canada and Australia are in the process of easing monetary policy or keeping interest rates at record lows in support of economic growth. These efforts are unlikely to let up anytime soon.

[1] Patti Domm (December 14, 2016). “Fed surprises with three rate hikes next year – and it could need to do more.” CNBC.

[2] Adam Chandler (January 18, 2017). “Why Would Donald Trump Want a Weaker Dollar?” The Atlantic.

[3] Tetsushi Kajimoto and Stanley White (February 12, 2016). “Exports prop up Japan fourth quarter GDP growth, U.S. protectionist risks loom.” Reuters.

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