With Donald Trump in power, the dollar is likely to rally but then weaken

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The writer is chief economist at Bank of Singapore

The return of Donald Trump to the White House is likely to mark the return of a stronger dollar in 2025.

Over the next few quarters, the change in presidency is set to push the euro down towards parity and the Chinese yuan from about 7.16 against the greenback to closer to 7.50, levels last seen before the 2008 financial crisis. If a full-scale trade war erupts in 2025, the euro and the yuan may even fall below their all-time lows of 0.82 and 8.73 hit in 2000 and 1994 respectively.

But over the course of Trump’s second term, the risks of political, fiscal, foreign and central bank crises may fully unwind the greenback’s current strength. Thus, investors shouldn’t rule out the dollar itself making new all-time lows over the next four years.

The new US government takes office in January. Initially, the dollar is likely to keep rallying against the rest of the major currencies.

First, the US fiscal deficit, already high at 6.5 per cent of GDP, is set to rise putting further upward pressure on Treasury yields. Trump is keen to extend the provisions of his first term’s 2017 Tax Cuts and Jobs Act, which will expire at the end of 2025. If the Republicans are unable to achieve a full sweep of Congress, the chances of a divided legislature renewing the tax cuts are still high. If the Democrats fail to regain the House of Representatives, the Trump administration will have little difficulty in reducing taxes even further.

Second, steep tariff rises next year will curb US demand for foreign goods and services. The president can set tariffs through executive orders without congressional approval. Trump has mooted a sweeping 10 per cent tax on all US imports and a punitive 60 per cent levy on Chinese exports. He may be willing to negotiate lower rates. But the threat of major tariffs will support the dollar by reducing America’s trade deficit and by stoking US inflation, making the Federal Reserve less likely to keep cutting interest rates in 2025.

Third, Trump’s plans to curb immigration are likely to tighten the US labour market. By also raising inflationary pressures, such action would similarly lower the chances of sustained Fed rate cuts next year.

Fourth, the prospects of tax cuts and widescale deregulation should keep supporting US markets. The outperformance of American stocks is likely to continue attracting capital inflows from the rest of the world.

Large budget deficits, steep tariffs, tighter immigration and buoyant markets are therefore set to strengthen the dollar during 2025. We expect the Fed, faced with the risk of US inflation rebounding, will only be able to reduce its benchmark fed funds rate to between 3.75 and 4 per cent next year. In contrast, the European Central Bank may need to slash interest rates well below 2 per cent if a trade war causes the Eurozone to falter.

The near-term strength of the dollar, however, isn’t likely to last throughout Trump’s four-year term. There are many longer-term risks to the greenback. The incoming president may press the Fed to keep cutting interest rates despite any rebound in inflation. Trump is also set to replace Jay Powell when his term as Fed chair finishes in May 2026. A pliant successor would undermine the dollar by raising fears over the central bank’s independence.

Rapidly rising fiscal deficits may also hurt the greenback if investors become reluctant to invest in US markets. The dollar’s status as the world’s reserve currency depends on the stability of US Treasuries. The greenback benefits from a lack of alternatives in the euro, yuan and Japanese yen. But a buyers’ strike in US government bond markets would still weaken the dollar sharply.

Similarly, investors may become unnerved if the Trump administration undermines the rule of law at home by using federal agencies to target domestic opponents or threatens world order by abandoning Ukraine, challenging China over Taiwan or pulling out of the Nato alliance. An unpredictable foreign policy would accelerate efforts by foreign countries to diversify away from the greenback.

Last, the Trump administration may turn against a strong dollar. In 1985, the Reagan White House helped devalue the currency through co-ordinated action with allied countries under the Plaza Accord. Investors shouldn’t therefore expect the dollar to stay strong forever when Trump returns. The greenback was also in demand at the start of George W Bush’s first term. But after hitting its all-time high of 0.82 against the euro in 2000, the greenback fell to an all-time low of 1.60 against the single currency near the end of Bush’s presidency in 2008.