Market Brief: Trump Trade Recovers, Pushes Dollar Higher

The almighty greenback is trading near a four-month high against its major rivals as market participants double down on the ‘Trump trade’ ahead of January’s inauguration date. With Republicans expected to cement control over both houses of Congress in the days ahead and early cabinet appointments exhibiting clear signs of a hawkish bent, the president-elect is positioned to implement an uncompromising policy agenda focused on lowering taxes, cutting immigration, rolling back the regulatory state, and raising tariffs against a broad range of trading partners - a mix that could raise inflation expectations and widen rate differentials in the dollar’s favour.

We would note that this trade didn't work out terribly well in Trump's first term - by the time tariffs were actually announced and implemented, growth expectations had fallen and the dollar was lower - but would also caution market participants against stepping in front of a speeding train. For now, the momentum behind the greenback looks well-nigh unstoppable.

The British pound is softer after pay growth slowed to its weakest pace in more than two years, giving the Bank of England room to cut rates more aggressively. According to the Office for National Statistics, average weekly earnings excluding bonuses rose 4.8 percent in the year ended in the third quarter, down from almost 8 percent in 2023, and dovetailing with a range of other indicators - including slowing hiring rates, rising unemployment, and falling vacancies - that are pointing to an easing in labour market conditions. Investors expect the central bank to stay on hold in December, with the next rate cut landing in January.

The euro is coming under sustained selling pressure as trade tensions grow and political uncertainty in Germany - the bloc’s largest economy - worsens. Chancellor Olaf Scholz’s “traffic light” governing coalition collapsed last week after he fired finance minister Christian Lindner when the latter opposed his move to suspend the “debt brake” - a cap on borrowing that limits the government’s capacity to provide domestic stimulus and increase aid to Ukraine - and a snap election has reportedly been scheduled for February 23, leaving the country economically rudderless at a time when the threat backdrop is darkening.

Markets are bracing for turbulence ahead. According to an update published by the ZEW Institute this morning, investors’ assessment of current economic conditions tumbled to the lowest levels since the pandemic in the last week, and president Achim Wambach pinned most of the blame on the growing likelihood of tariffs that could hurt the country’s export sector, saying “the outcome of the U.S. presidential election is likely to be the main reason for this”. Economic policy uncertainty climbed in October - outpacing increases in other trade-dependent regions - and looks set to push higher still in the months ahead, putting pressure on the European Central Bank to cut interest rates more quickly.

The Canadian dollar is trading near lows last reached in October 2022, and is edging closer to breaking through support to the downside. With markets pricing in a slower pace of easing from the Federal Reserve than the Bank of Canada over the next year, rate differentials keep widening against the loonie and traders worry that this pressure could intersect with hostile rhetoric from Donald Trump in the coming weeks to push the exchange rate through the psychologically-important 1.40 threshold against the dollar. We think that such an overshoot could set the stage for a fairly sharp rebound early in the new year - recent data suggest that the domestic economy is weak, but not recession-esque - 270,000 jobs have been added over the last year, housing markets are showing clear signs of a rebound after sales jumped by double-digits in Toronto and Vancouver last month, and exports are likely to grow if animal spirits are reinvigorated in the US. A move down to 1.43 is possible before year end, but weakness shouldn’t necessarily be extrapolated forward.

China’s yuan remains deeply depressed, with the offshore exchange rate knocking on a three-month low. Friday’s stimulus announcement from the National People’s Congress proved underwhelming as officials delivered a raft of measures aimed at stabilising local governments but stopped short of meaningfully supporting the wider economy. Data released over the weekend showed domestic credit flows expanding by less than expected in October, suggesting that business investment continued to weaken. And a series of reports indicating that president-elect Trump is preparing to nominate a cast of China hawks to lead his administration’s approach to foreign policy - including Robert Lighthizer as trade representative, Marco Rubio as secretary of state, Representative Mike Waltz as national security adviser, and Elise Stefanik as UN ambassador - have hampered demand for the currency. We think structural reforms will accelerate by the middle of next year, helping offset a tariff-related shock to external demand, but in the here and now, the People’s Bank of China seems likely to slow-walk the dollar-yuan exchange rate toward the 7.30 threshold.

This afternoon’s loan officer survey could help bolster confidence in the economy’s underpinnings. The Fed’s latest Senior Loan Officer Opinion Survey is expected to show lenders tightening lending conditions at a more modest pace, helping support increased credit growth and delivering an incremental boost to underlying demand.

Like the October payrolls report, tomorrow’s inflation report could be heavily distorted by the impact of hurricanes Helene and Milton - meaning that it is unlikely to impact monetary policy expectations in a material way. Investors expect a 0.3 percent monthly change in core prices, keeping the year-over-year pace at 3.3 percent for a third consecutive month - but an upside shock should be considered well within the realm of possibility. Overall inflation surprise indices have risen in recent months, but remain below the levels that preceded the run-up to the post-pandemic price surge - and recent Fed communications have been overwhelmingly consistent with a tilt toward a labour market focus, implying a reduced importance for inflation data.

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