The fall in the dollar is not scary

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The dollar’s recent decline is not about ‘safe haven’ status

The dollar keeps getting weaker, and has now broken though the bottom of its 2022-2025 trading range:

Much of the punditocracy sees this as a symptom of fiscal and monetary mismanagement by the Trump administration, which is drawing the safe haven status of the dollar into question. This, for example, comes from a piece in the FT yesterday (“US dollar suffers worst start to year since 1973”):

“The dollar has become the whipping boy of Trump 2.0’s erratic policies,” said Francesco Pesole, an FX strategist at ING. 

The president’s stop-start tariff war, the US’s vast borrowing needs and worries about the independence of the Federal Reserve had undermined the appeal of the dollar as a safe haven for investors, he added . . . 

And here’s an example from an FT piece from Sunday (“Donald Trump’s fiscal policy and Fed attacks imperil US haven status, say economists”):

“Fiscal deficits, deliberate government actions to shrink the US financial account and devalue the dollar, uncertainty about succession at the Fed and questions about Fed independence all negatively affect [the safe haven status of the dollar],” said Anna Cieslak at Duke University.

Unhedged doesn’t buy it. Confidence in the dollar system had a bad shock in April, after the president’s absurd Rose Garden performance on “liberation day”. But as an explanation of what is going on over the past month or so, the loss of safe haven status simply won’t do. Look at what is happening at the same time:

2-, 10- and 30-year Treasury yields are falling 

Inflation break-evens are falling

Equities are hitting all-time highs

Corporate bond spreads are back near all-time tightness

Gold has been heading sideways (albeit at a high level) for two months 

Implied volatility of equities and bonds is low 

None of this is consistent with global investors exiting US dollar assets, a witless lackey being appointed Fed chair, a horrific failure of tariff negotiations, or a spiralling deficit/rates crisis. One might perfectly well argue that the market is wrong about all these things. Markets do go through periods of being mostly wrong. But the market simply is not saying the safe haven status of dollar assets is under increasing stress.

Indeed, the opposite is closer to the truth: since the April scare, the policy outlook has become steadily less frightening. That, plus signs of a gently weakening economy, has raised expectations for Fed rate cuts and allowed long-bond yields to fall, as well. In that context, a falling dollar is normal.

The budget

The Senate votes on the “big, beautiful bill” this week. The proposed law represents all of Trump’s signature spending proposals rolled into one. It contains measures ranging from child tax credits to border security, and even tucks in a long-awaited increase to the debt ceiling. 

For investors, the specifics of the budget bill matter insofar as they affect specific industries. But, more important is the sheer amount of spending: how much it adds to the deficit relative to the market’s previous expectations.

The most expensive part of the bill is the extension of Trump’s 2017 tax cuts, which make up about 90 per cent of the total tax cuts in the bill, according to Shai Akabas at the Bipartisan Policy Center. But the extension of those cuts was already expected by the market — all budget trickery aside. What is surprising is the additional tax cuts and spending that were layered on top. A few worth calling out include eliminating taxes on overtime ($90bn addition to the deficit over 10 years, according to the Congressional Budget Office’s most recent estimate), tips ($32bn), and car loans ($31bn), as well as new spending on defence ($149bn) and border security ($129bn).

Below is a chart showing the CBO’s baseline forecast of the total deficit from January 2025, that is, the deficit forecast if the laws on the books remain generally unchanged; the CBO’s deficit forecast after the House bill passed; and its most recent deficit forecast, based on the contents of the Senate bill:

Notice that the deficit expands faster in the first few years of the bill. That is by design. A lot of the new tax provisions — no tax on tips, no tax on overtime — are set to be spent between now and the end of the Trump administration. “The fiscally stimulative part is going to be spent in 3.5 years, not 10 years, like previous bills”, said Ed Mills at Raymond James. For equities, this is probably a good thing in the near term. A bigger fiscal impulse pushes money into the system, and that money tends to wind up on corporate balance sheets and in investors’ brokerage accounts. 

But widening the deficit will push up interest costs. “In [the bill’s] current form, the US’s interest expenses will go up to 25 per cent [of total revenue] from 22 per cent. That means 1 in every 4 dollars the US takes in will go to paying off the national debt,” said Akabas at the Bipartisan Policy Center.

At some point, higher deficits and debt-maintenance costs cease to be sustainable. Interests rates begin to spiral upwards. The country is forced into austerity, financial repression, or high inflation. Bonds will be crushed and equities will not be spared, either. We do not know whether this is that point. But we know this bill will bring us closer to it.

(Reiter)

One good read

Spy Kids.

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