Episode Details

Our U.S. Public Policy and Currency analysts, Ariana Salvatore and Andrew Watrous, discuss why the dollar fell at the beginning of the first Trump administration and whether it could happen again this year. 

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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Morgan Stanley's U.S. Public Policy Strategist.

Andrew Watrous: And I'm Andrew Watrous, G10 FX Strategist here at Morgan Stanley.

Ariana Salvatore: Today, we'll focus on the U.S. dollar and how it might fare in global markets during the first year of the new Trump administration.

It's Tuesday, March 4th at 10am in New York.

So, Andrew, a few weeks ago, James Lord came on to talk about the foreign exchange volatility. Since then, tariffs and trade policy have been in the news. Last night at midnight, 25 percent tariffs on Mexico and Canada went into effect, in addition to 10 percent on China. So, let's set the scene for today's conversation. Is the dollar still dominant in global currency markets?

Andrew Watrous: Yes, it is. The U.S. dollar is used in about $7 trillion worth of daily FX transactions. And the dollar's share of all currency transactions has been pretty stable over the last few decades. And something like 80 percent of all trade finance is invoiced in dollars, and that share has been pretty stable too.

A big part of that dollar dominance is because of the depth and safety of the Treasury security market.

Ariana Salvatore: That makes sense. And the dollar fell in 2017, the first year of the Trump administration. Why did that happen?

Andrew Watrous: Yeah, so 2017 gets a lot of client attention because the Fed was hiking, there was a lot of uncertainty about would happen in NAFTA, and the U.S. passed a fiscally expansionary budget bill that year.

So, people have asked us, ‘Why the U.S. dollar went down despite all those factors?’ And I think there are three reasons. One is that even though the possibility that the U.S. could leave NAFTA was all over the headlines that year, U.S. tariffs didn't actually go up. Another factor is that global growth turned out to be really strong in 2017, and that was helped in part by fiscal policy in China and Europe. And finally, there were some political risks in Europe that didn't end up materializing.

So, investors took a sigh of relief about the possibility that I think had been priced in a bit that the Eurozone might break up. And then a lot of those factors went into reverse in 2018 and the U.S. dollar went up.

Ariana Salvatore: So, applying that framework with those factors to today, is it possible that we see a repeat of 2017 in terms of the U.S. dollar decline?

Andrew Watrous: Yeah, I think it's likely that the U.S. dollar continues to go lower for some of the same reasons as we saw in 2017. So, I think that compared to 2017, there's a lot more U.S. dollar positive risk premium around trade policy. So, the bar is higher for the U.S. dollar to go up just from trade headlines alone.

And just like in 2017, European policy developments could be a tailwind to the euro. We've been highlighting the potential for German fiscal expansion as European defense policy comes into focus. And unlike in 2017, when the Fed was raising rates, now the Fed is probably going to cut more this year. So that's a headwind to the dollar that didn't exist back in 2017.

So, on trade, Ariana. What developments do you expect? Do you think that Trump's new policies will make 2025 different in any way from 2017?

Ariana Salvatore: So, taking a step back and looking at this from a very high level, a few things are different in spite of the fact that we're actually talking about a lot of similar policies. Tariffs and tax policy were a bi