Dan Mitchell, Senior Portfolio Manager, RBC Global Asset Management Inc., discusses the strengthening of the U.S. dollar following the U.S. elections, unfavourable news from Europe and China, as well as expected inflationary policies from the new Trump administration. The recent developments have prompted a reassessment of the U.S. dollar's trajectory, postponing the anticipated decline. Despite the current trend, long-term forecasts indicate a potential weakening of the dollar, attributed to trade and fiscal deficits, along with a global shift towards diversifying away from the dollar.
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What is the outlook for the U.S. dollar considering recent political and economic developments?
The U.S. dollar has rallied since the early November U.S. elections, and that's taken the dollar beyond the well-established range that has been in place for the past two years, and hints that we might see a little bit more exchange rate volatility in the year ahead. Now, part of the U.S. dollar strength that we've seen simply been from negative news, both political and economic, coming out of Europe and China.
But it's also a market reaction to some of the proposed policies coming out of the Trump administration. From taxes to tariffs to immigration policies, there's an inflationary bent to some of those proposals, and that's going to keep the Federal Reserve from cutting interest rates as much or as quickly as markets expect. And it will keep capital flowing into the United States as investors chase those higher yields.
So as a consequence, we've amended our outlook for the U.S. dollar. We've pushed back our expectation for when that U.S. dollar weakness might materialize. But we do expect the U.S. dollar to weaken in the longer term, because a lot of the factors that we monitor still argue in that direction. You've got the U.S. dollar, that is still very overvalued on most models.
We have U.S. trade and fiscal deficits that are quite large and expected to continue for the foreseeable future. And we've got countries starting to shift away from using the U.S. dollar. Both in the way that they're buying gold to diversify foreign exchange reserves, and in the way that they are using other currencies to settle global trade.
Ultimately, though, the sequence, the timing, the magnitude of the dollar's moves from here will heavily depend on how these Trump policies get implemented. A very heavy hand on tariffs right off the bat would certainly be U.S. dollar positive, but we expect a more conciliatory tone, in the way that those tariffs are implemented in perhaps a more staged way in order to extract as much as possible in negotiations with trading partners.
And in particularly in the case of Canadian dollar for those tariffs to be focused on specific sectors. Altogether, we expect the U.S. dollar to remain resilient for the next several months and quarters, but eventually to weaken. And we've penciled in only modest gains from the euro, the Japanese yen, the pound and the Canadian dollar.
