The dollar index is down another 0.3% at the start of this week's trading after falling nearly 1% as last week’s trading closed. Normally this would not be cause for alarm. While major currencies do not typically fall 1% in a single day, it is not out of the ordinary if they do once in a while. In the case of the dollar, however, this is cause for concern.
The index tagged three-year support levels at the beginning of August and bottomed at 92.39, just above the key 91.88 level. As expected from major support levels like this, it bounced. The bounce took it up to 94 by mid-August, but has since fallen back down to 92.34, retracing and even technically breaking the entire bounce back up to 94.
From a technical perspective, if there is no immediate double bottom set this week, we could easily see a waterfall decline. The question is, are there fundamental reasons for the dollar’s weak performance? Arguably, yes, and they have to do with the Trump administration's trade policy.
President Trump has repeatedly bemoaned the balance of trade of the U.S., decrying the fact the country is at a persistent trade deficit, especially with China of $358 billion and growing. One of the keystones of his tenure is to make trade more “fair” in his perception, meaning get rid of, or at least lighten, the lopsided U.S. balance of payments.
The term “deficit” though is misleading. It implies the U.S. owes something to the trade partners with which it has this so-called deficit. However, this is not the case. All that a negative balance of trade means is the value of imports exceeds the value of exports in dollar terms, but no debt is involved. The difference in value is made up by dollars exported to pay for it. For example, if the U.S. trade deficit with China is $358 billion, that means $358 billion is being exporting to China.
What does this have to do with the dollar index? Simple. The dollar index topped out at 103.81 on Jan. 3, within two weeks of Donald Trump taking office. Since then, it has fallen 11%, a huge move for a currency in less than nine months. If Trump succeeds in evening out the balance of trade either by tariffs or trade deals that discourage imports and encourage exports, that means the U.S. will be exporting less dollars and, by extension, more dollars that otherwise will stay within American borders and be available to bid up goods and services. The supply of dollars within the U.S. rises more than otherwise, lowering purchasing power and lowering the value of the dollar.
Currently, Trump is close to imposing trade sanctions on the Chinese, who have already threatened to retaliate. The timing with the dollar being very close to breaking three-year support levels is probably not a coincidence.
Expect the dollar to experience a waterfall decline if trade relations with the Chinese markedly deteriorate and, in turn, for the inflation rate to rise much faster than it currently is.
Disclosure: No positions.
