Try Googling “Trump and Reagan” and you will get plenty of material on the comparison between the two, on so many fronts. Even in the financial markets, the foreign exchange market seems to have started to price in a scenario that the Trump presidency will be something like Reagan’s in the 1980s – a scenario that includes a U.S. dollar boom.
Consisting of a potent mix of tax cuts, government spending and higher interest rates, President Reagan’s economic policies helped push the U.S. dollar straight up during his first presidential term. Between January 1981 (President Reagan’s inauguration) and February 1985 (the U.S. dollar’s all-time peak), the US dollar rose 81%.
Source: Bloomberg as of Nov.18, 2016
Since Trump’s election victory, bond prices have fallen and stocks have risen, with markets anticipating that Trump’s proposals to cut taxes and boost infrastructure and defence spending will lead to faster inflation and stronger growth. Fed Chair Janet Yellen has also signalled that an interest rate hike could come “relatively soon.” A mix of loose fiscal and tight monetary policies was the exact recipe for a strong U.S. dollar in Reagan’s era. History seems to be repeating itself, and the U.S. dollar touched a 13-year high within ten days after Trump’s election.
However, with so many uncertainties in the prospects for the U.S. economy, Trump-Reagan parallels for the U.S. dollar may not be as straightforward as they first seem.
Uncertainty 1: Fiscal sustainability and the trade balance
According to some critics, Trump’s aggressive fiscal policies could in the future make the U.S. look like a current peripheral European country: “The debt-to-GPD ratio under the Trump plan goes from 77% today to 105% by 2026,” and the “debt-servicing cost, which now absorb 7 cents of every federal revenue dollar, will drain 25 cents by 2020.”*
Trump’s protectionist trade policies run the risk of retaliation by trade partners. Instead of strengthening U.S. trade accounts, a trade war with China, Canada or Mexico could result in a wider current account deficit.
The rising twin deficits typically put downward pressure on currencies, and this could ultimately undermine the U.S. dollar.
Uncertainty 2: Federal Reserve policy
Reaganomics was a reaction to the high inflation of the 1970s. Hiking rates and fighting inflation was the single most important mandate for Paul Volcker when he became the Chair of the Federal Reserve (the Fed) in 1979. However, Trump’s backdrop is one of low inflation, real growth and secular stagnation. Fed Chair Janet Yellen said in October that the Fed might want to run a “high-pressure economy” to allow inflation to overshoot the 2% target. The Fed is likely to lag behind inflation and see a decline in real rates, which might make the U.S. dollar less attractive over the mid-term.
Uncertainty 3: The appeal of U.S. assets
When Reagan took the White House, U.S. assets, including the U.S. dollar, U.S. equities and U.S. Treasuries, were at historic lows. Trump, by contrast, inherits one of the longest bull markets for both equities and bonds. The economy is expanding into a mid-to-late cycle, and asset prices are all at or close to historical highs. A headwind of deflating asset prices is more likely than not under Trump’s watch.
Source: Robert Shiller http://www.econ.yale.edu/~shiller/ as of Oct.31, 2016.
Under Trump, neither Fed policy tightening nor fiscal stimulus is likely to be as effective as it was as part of Reaganomics, which was applied at a time when both tax rates and interest rates were much higher. Questions about fiscal sustainability and the trade balance will trouble investors over the longer term. An increasingly stronger currency may not be in the best interests of Trump’s economic plan, which pledges to bring jobs back to the U.S. – something that would be harder to achieve with a strong U.S. dollar. A weaker currency may be desirable instead. And it would be even more challenging to recreate the bullish currency of the 1980s without the tailwind of rising asset prices.
The trading environment supports the dollar in the short run. But the long-term implications of the macroeconomic policy mix are more complicated, and the market may be running a risk of getting ahead of itself by trading on convictions about Trump-Reagan parallels leading to a secular U.S. dollar boom.