US DOLLAR STRENGTH
There are several inter-related drivers that can explain the US dollar’s strength since Trump’s election win.
From a policy point of view, the incoming Trump 2.0 administration is likely to extend tax cuts further and intensify trade tariffs against China and potentially other countries such as Canada and Mexico. This will increase the cost of goods and services for the US.
Our analysis suggests that a staggered and phased rise of American tariffs will likely contribute to a moderate rise of 0.3 percentage point in the US consumer price index (CPI) in 2025. However, in a more pessimistic scenario of an immediate jump in tariffs upon Trump’s inauguration on Jan 20, there will be a jump of at least 0.5 percentage point in the US CPI.
In short, Trump’s policies may well reignite inflation for the US.
In fact, the latest data showed that the CPI has stayed firm at 2.7 per cent year-on-year in November, raising risks that the United States’ progress on its path towards the Fed’s long-term target of 2 per cent inflation may have stalled.
Consequently, renewed inflationary risks implies lower odds of Fed rate cuts for 2025. At the latest Federal Open Market Committee meeting on Dec 18, the Fed indeed signalled a shallower rate cut trajectory.
The Fed’s updated projection now implies only two rate cuts for 2025, fewer than the previous projection of four cuts. Fed chair Jerome Powell also sounded less committal about further rate cuts going forward, warning that “the slower pace of projected cuts … reflects the higher inflation expectations”.
The renewed inflationary risk, coupled with shallower Fed rate cuts and higher long-term yields, all contribute to the strong US dollar we’re now seeing.
This strength will likely continue, with the DXY rising further above 110 by the middle of 2025 and the 10-year US Treasury yield staying firm above 4 per cent.
