Dollar touches 2-year high on Trump’s return. How long will the rally last?

President-elect Donald Trump is often referred to as an agent of chaos. He has threatened allies with the annexation of land and vowed to use economic force to nudge Canada into becoming the 51st US state.

He also wants to curb the number of immigrants, considered a major engine of economic growth, while imposing unusually high tariffs on imports from countries like China that make everyday goods affordable for the average US consumer.

In theory, his antics should have sent investors scurrying for cover. After all, smart money takes flight whenever military adventurism, trade barriers and labour market chaos appear on the horizon.

But the opposite seems to be happening in the US.

The US currency is growing from strength to strength. The dollar’s value against major global currencies is hovering at a two-year high.

The rally in the dollar started in September when Trump’s chances of winning a second term became apparent. Its upward movement has continued ever since, according to the US Dollar Index, a measure of the dollar’s value relative to a basket of major currencies.

The surge in the dollar’s value means international investors continue to view it as a safe haven. Its demand is rising as individuals and companies around the world remain eager to convert their holdings into dollars.

Their assumption is that the dollar’s value will keep rising against other currencies under Trump’s presidency.

The euro lost 4.9 percent against the dollar in recent times. The declines in the values of the pound sterling and Chinese yuan against the dollar were 5.2 percent and one percent, respectively.

Experts, however, have a counterintuitive explanation why Trump’s unconventional take on key economic matters is strengthening the dollar.

The expected turbulence in the US economy in the coming days is actually a source of strength for the dollar.

“Tariffs and some of the other policies (like) mass deportations would add upward pressure to prices and wages in the US, which would mean… higher interest rates,” Yougesh Khatri, an associate fellow at British think tank Chatham House, tells TRT World.

Increasing tariffs on imports and deporting foreign workers will make the prices of everyday items expensive in the US. In order to tame that inflation, the US central bank will have to increase interest rates.

In turn, a higher interest rate will make the US currency more attractive for global investors.

The prospect of higher inflation in the US is, therefore, a driver of the dollar’s growing international demand.

Tariffs, immigration and tax cuts

There are three core economic-policy agenda items of the Trump administration: higher tariffs, fewer immigrants, and lower taxes. Each one of these creates inflation, according to Thierry Wizman, a currencies strategist at global financial firm Macquarie.

Trump’s expected policy and its potentially inflationary implications are the “main driver of recent dollar gains”, Wizman said.

In the 2024 presidential campaign, Trump talked about imposing minimum tariffs of 10 to 20 percent on all imported goods, except shipments from China that would attract tariffs of 60 percent or higher.

Tariffs burn a hole in the consumer’s pocket as most retailers tend to pass on the added costs. Consumers, as well as businesses, will face a “massive burden” because of Trump’s proposed tariffs as prices of daily-use items at the grocery store will rise, according to a report by think tank Third Way.

Similarly, Trump’s immigration policy, which includes deporting 11 million undocumented workers, will cause a “gargantuan shock” of trillions of dollars to the economy.

“It will quickly raise inflation, by reducing the capacity of US firms to supply goods and services faster than it reduces demand,” said Michael Clemens, an economics professor at George Mason University who focuses on migration.

Trump is also likely to extend the expiring tax cuts and possibly offer new tax breaks that could “stoke demand just as the (US central bank) is aiming to cool it”.

Tax cuts leave individuals with more disposable income and businesses with higher profits. All this additional money stokes demand for goods and services, creating inflation in the short run.

A strong-dollar advocate

Trump is likely to “prioritise” US domestic demand through higher tariffs, Gary Ng, senior economist for Asia Pacific at Hong Kong-based Natixis Corporate and Investment Banking, tells TRT World.

“As central banks in other countries may cut (interest) rates faster and more than the US, the yield divergence may lead to a stronger greenback,” he says. Yield divergence refers to the difference between rates of return in major economies of the world.

“This can make US assets more attractive compared to other markets,” he says.

The incoming US president is supposed to be a strong-dollar advocate. He told Bloomberg last year the US had “big currency problems” particularly against the Japanese yen and the Chinese yuan.

Scott Bessent, who will likely lead the Treasury Department in the incoming Trump administration, said that Trump would not let the dollar weaken because the president-elect wanted it to remain the world’s reserve currency.

“I believe that if you have good economic policies, you’re naturally going to have a strong dollar,” he said.

The IMF expects the US to grow this year by 2.2 percent versus 0.8 percent expected growth in Germany, 1.1 percent in Japan and 1.5 percent in the UK.

But how long the dollar rally will sustain is something that only time can tell.

Barry Eichengreen, a professor of economics at the University of California, says the strength of the dollar has rested on the strength of the US economy. But the proposed tariffs are “incompatible” with that strength, he insists.

“Trump is an uncertainty machine. At some point, foreign exchange traders will cotton on to this fact,” he says, noting that the dollar's short- and longer-term prospects remain at odds.