​Incoming Administration and Interest Rates Catalyze Strong Dollar Tailwinds Entering 2017

Luis Aureliano |

The US dollar could continue its year-end momentum upwards in 2017 thanks to a variety of strong tailwinds. An incoming administration that is hawkish on several key policy aspects, as well as a US Federal Reserve that is seeking to more rapidly normalize monetary policy could provide a strong catalyst for sustained US dollar gains.

President-elect Donald Trump has already outlined several policy proposals aimed at reshaping corporate taxation as well as infrastructure spending. Adding to the positive outlook is the Central Bank signaling that economic conditions will enable it to raise the benchmark interest rate significantly quicker in 2017. Combined, these policies could lead to a stronger and scarcer dollar as liquidity is slowly drained, sending the US currency bounding higher as yields rise.

While many expected Trump’s election to have a similar short-term impact as that felt by the United Kingdom following “Brexit”, those fears have been largely unfounded. Moreover, the US dollar’s trajectory has diverged significantly from its major peers, as uncertainty in Europe has kept the Pound and the Euro depressed while the dollar has steadily climbed.

Dollar Looking to Run Away from Rivals

As European currencies continue to plod along thanks to uncertainty and a rash of losses for policymakers in power, the dollar has been quietly building up steam. After showing weakness early in the year, the last half of 2016 saw the US currency take a sharp upward turn while its counterparts sank on growing economic and political risks.

Now, with Trump set to unleash a stream of stronger fiscal spending and the potential for monetary policy normalization, the dollar is set for an even bigger run in 2017. Trump has been outspoken about his aims to expand infrastructure spending heavily while reworking the corporate tax code. Additionally, his nominations to economic posts in the administration have given markets confidence about the future of the US economy.

All of these moves point toward a strong chance US dollar repatriation and greater corporate investment in the US, driving up the US currency against its peers. Trump’s taxation plan, specifically, could lead to a strong influx of cash by US multinationals that hold their cash offshore. With expanded spending on infrastructure, a Trump presidency could improve growth, tax collections, and help push the government towards a surplus after over a decade in deficit. Taken altogether, the effect of Donald Trump’s policies on the US economy could spur a rush to purchase US dollars and bonds, leading to a rapid rise in the currency’s value.

The Fed adds Fuel to the Fire

On top of President-elect Trump’s predicted impact, the US Federal Reserve’s surprisingly hawkish tone on monetary policy has emboldened markets, and has set it on a path for divergence from its major peers. While most developed economies have been battling disinflation and deflation by lowering rates—in some cases deeply into negative territory—the US is set to buck that trend. After its first interest rate hike in nearly a year, the Fed has noted that it expects a further three increases over 2017 based on the perceived strengthening of the US economy.

If that happens, the US dollar should continue its strong march upward against a basket of its peers, while other currencies remain depressed under the weight of accommodation. Immediately after the report on December’s hike, the dollar reached a 14-year high. While it is no guarantee that the Fed will act (in 2015 it announced plans for four increases in 2016), the US economy is in a much better place heading into 2017, with unemployment down at record levels and most fundamentals back on track.

What Does It All Mean for the Dollar?

All of these factors point toward a record year for the dollar. While many peers remain mired in uncertainty, austerity, and negative inflation rates, the US is set to expand fiscal policy, and has taken normalization efforts for its monetary policy. According to 24Option's senior analyst – "the upside risks for the US dollar far exceed the downside potential over the near-term amid the continued divergence in monetary policy across advanced economies".

While there are certainly still risks for the dollar outlook, all the dominoes are in place for a strong 2017. The US will likely outperform most advanced economies, and Donald Trump, despite his election histrionics, could be an unexpectedly positive factor for the US economy. With a budget surplus and more cash coming in, it is not hard to see how the dollar could regain its former glory.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer


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