Why the Trump effect matters for investors betting on a strong US dollar

Thus, the Fed seems willing to risk the return of inflation, as that would erode the real value of the current debt overhang, which is good for the American debtor – the largest being the US government. Inflation is already being seen in the trend that producer price indices are now rising faster than consumer price inflation.

Of course, US interest rates cannot be independent of rates in other major economies. So far, the Bank of Japan has been keen to continue its quantitative easing and keeping interest rates near zero to get inflation back to the target of 2 per cent.

As long as Italian and Greek banking problems remain unresolved, the European Central Bank is keeping euro interest rates low.

But with Germany running a current account surplus of over 8 per cent of GDP , with the overall euro zone figure at 3 per cent of GDP, the broad consensus is that Europe is finally beginning its recovery, with the euro continuing to strengthen against the dollar.

Earlier this month, when Trump appeared politically under siege after his firing of FBI director James Comey, the markets reversed from recent heights and the dollar weakened. The issue is whether the Trump stock market rally has peaked.

The fortunes of the dollar have a significant impact on the course of the renminbi. After nearly 18 months of downward pressure due to capital outflows, the People’s Bank of China has managed to contain the loss of foreign exchange reserves and maintained the currency’s stability against the dollar. But the loss of nearly US$1 trillion in foreign exchange reserves has tightened domestic liquidity and domestic interest rates have edged upwards.

This is expected, as outflows cause loss of renminbi deposits in exchange for foreign currency. So the central bank needs to provide continuous funding to ensure the domestic liquidity situation does not create a credit crunch. It needs to maintain a tight monetary stance, because excess liquidity flows out and hurts foreign exchange reserves; too little liquidity risks credit defaults. Getting the balance right is more an art than a science.