Explore the twin forces of market volatility and a weakening dollar, from political uncertainty to presidential strategy, and learn how to navigate Chapter II.
KEY TAKEAWAYS
-
Markets closed H1 at record highs despite a modest 5.5% year-to-date gain
-
The U.S. Dollar Index has weakened sharply since inauguration
-
Primary drivers include ballooning fiscal deficits, a dovish Fed outlook, trade war uncertainty, and political risk
-
A weaker dollar benefits U.S. manufacturing exports and makes repatriation more lucrative
-
Costs include pricier imports, more expensive travel, and potential near-term capital outflows
MY HOT TAKES
-
Heightened volatility demands higher returns, but investors may feel underpaid so far this year
-
The dollar’s decline reflects both economic fundamentals and deliberate policy strategy
-
Trade war flip-flopping adds a layer of uncertainty that undercuts the greenback
-
The Fed’s dovish stance exacerbates capital migration to higher-yielding markets
-
Despite short-term currency swings, classic economics suggests long-run parity will eventually return–if we are still alive
-
You can quote me: “Wait what—a weaker dollar ? Nobody wants that ! But Trump does.”
Double edge. Welcome to 2025, chapter II. Chapter I certainly set the stage for this very-much fluid action adventure, featuring a bit of romance, jilted lovers, loss, rebirth, pain, pleasure, war, peace… epic, that’s the word I am looking for. This novel has us all on the edges of our seats, wondering how Chapter II will end, and more importantly, because we are only at its beginning, what will the journey be like? Will it be fraught with more of the same as Chapter I? Will there be blood? Resolution? Well, it seems, certainly at this stage, that we can at least count on more of what we got in the first chapter: volatility. We did manage to close the first half of the year at record-highs in equities, but it was not an easy journey, moreover, in case you haven’t noticed, we have very little to show for our toils. Though we have made fantastical returns since the market bottomed out in April, we are only up by 5.5% for the year.
In any normal year, based on statistics, that would be considered perfect; roughly ½ the long-run average annual return of the index… in a ½ a year! 🥳 But given the market’s more recent returns, some investors might be disappointed if the S&P only logged a 10% return for the year. Besides, the type of stress and volatility investors had to endure, many would expect greater than average returns. More volatility requires higher returns! That’s Finance 101!
Well, we are here, and surely there are lots of great things to come as trade negotiations wrap up, the Big Beautiful Bill (or some form of it) gets signed, hopeful lasting peace in the Middle East, the Fed may decide to get back in the business of… er, central banking, and a weaker dollar. “WAIT WHAT,” you exclaim! “A weaker Dollar?” “Nobody wants a weaker Greenback!”
Well, I know someone who wants a weaker dollar, and it may surprise you that the President would like a weaker Dollar. And he has said as much, and whether by plan or happenstance–I can’t tell you which–he is achieving his goal. Take a look at this chart of the Dollar Index then keep reading to find out why.
This chart is of the Dollar Index. Briefly, the U.S. Dollar Index (DXY) measures the value of the U.S. dollar against a basket of six major world currencies to gauge its overall strength. A rising index means the dollar is strengthening relative to those currencies, while a falling index indicates it’s weakening. You can see by the chart that the Dollar surged higher after President Trump was elected and it fell in rock-like fashion since his inauguration. Now I am sure that I don’t have to tell you what the major driving factor of the decline was. But in reality, there are many things that determine movements in currencies. Clearly, prospering countries’ currencies tend to strengthen. Of course, you can also say that a country’s currency can strengthen if its trading partners economies weaken. I don’t want to confuse you, but you have to understand that currency strength is measured in relative terms. Relative to a trade partner, or a group of trade partners.
Why has the Dollar collapsed in the months since inauguration? There are several reasons, amongst them are ballooning fiscal deficits, a dovish Fed, trade war uncertainty, and political uncertainty.
The US already has a sizable debt burden and deficit, and it is likely to swell further yet. This makes investment in the U.S. technically riskier, and therefore, investors demand higher yields to take on the risk. Weaker currencies make returns in U.S. investments higher.
The most basic driver of currency movement is interest rate parity. Investment dollars generally move to investments with the highest risk-adjusted returns. Assuming that G7 nations all have similar risk (although that’s stretching it a bit), investors would simply sell in lower yielding countries and buy in higher yielding countries. That requires currency conversion which strengthens the higher yielding country’s currency. If the Fed is expected to lower interest rates, investment capital may shift out of the U.S., causing Dollars to weaken. Keep this thought in your mind.
Trade war uncertainty is an interesting one, because technically, a country which is charging the tariffs would enjoy a stronger currency. In this case the U.S. is the taxer which should technically weaken foreign economies thus, strengthening the dollar. We certainly witnessed expectations of that in the period between elections and the inauguration, however, that changed starkly since the President started his tariff campaign just days after he took the reins. In this case, it is more likely the uncertainty caused by the on-again-off-again, larger-than-imagined tariffs being haggled over between the U.S. and, literally, everyone. You could call it a row with the R.O.W. A row, pronounced /rou/, like cow, is a fancy word for an argument, and R.O.W. is a fancy investment banking / management consult acronym for Rest Of World.
That brings us to general political uncertainty. If hostile political environments prevail in certain countries, investors may choose to move their investment capital to more benign domiciles. That causes local currency liquidation, resulting in currency weakness. Though there is no way to trace it, many have speculated that foreign investors have moved money out of the U.S. since Trump began his tariff assault, causing not only Dollars to fall but Treasury Note yields to climb as prices fall due to the selling. One can certainly make the case that demand for U.S. Treasuries has waned as a result of expected deficit / debt increases and political uncertainty. It works like this: foreign investors sell Treasuries, exchange currencies, then move investments elsewhere. The net result is higher Treasury yields and a weaker dollar.
Ok, so why then would President Trump favor a weaker currency? Let’s remember that a big part of the President’s strategy is to bring manufacturing back to the U.S. and create manufacturing jobs. A weaker currency makes U.S. products cheaper to foreign buyers, that should, in theory, juice demand for U.S. goods. This can also serve to lower the trade deficit and possibly blunt some import-tariff pain.
A weaker dollar also makes currency repatriation more appetizing for U.S. companies. Bringing revenue earned abroad back to the U.S. is not only good in theory, but it is also good for revenue growth, though not technically. Technically, it is a revenue “boost,” because foreign revenue already earned is worth more in Dollars when the currency is weaker.
There are many reasons why a head of state may want a weaker currency, but the main justifiers are a boost to the local economy and manufacturing. Unfortunately, however, there are costs as well.
The most notable is that weaker U.S. Dollars make foreign goods more expensive. Looking to travel abroad this summer? That espresso on Lake Como is going to cost more this summer than it did last summer and not because of inflation. No. Your dollar will get you less Euros–that is, you will have to trade more dollars to get the same good. I don’t know about you, but €1.10 doesn’t seem so bad for an espresso. That is roughly $1.39, which also doesn’t seem so bad, but if you knew that last summer, the same €1.10 espresso would have cost you $1.10, you may be disappointed. I guess that still sounds cheaper than the 2,000 lira it would have cost if Italy didn’t switch to the Euro in the late 1990s. That was a nerd joke–it's still all about conversion rate.
Finally, I want to note that if foreign investors expect the Dollar to weaken further, they may choose to invest elsewhere. This could depress stock and bond returns in the near-term and cause a boost in foreign investments.
Taking a GIANT step back, classic economics teaches us that, despite all this jockeying back and forth, everything will swing back into parity in the long run. A classic Economist once said that “in the long run, we are all dead.” For today, however, we are still here, and today, the dollar is weakening, which will only add to further volatility in Chapter II of 2025. Are you ready for Chapter II? Buckle up, it’s going to be a bumpy one.
YESTERDAY’S MARKETS
Stocks gained yesterday to finish the quarter on a record high helped along by calming nerves between the US and Canada. The Senate failed to advance the Big Beautiful Bill, but they are hammering away at it, still hoping to get it done by the end of the week. Traders await a raft of important jobs numbers that will be released starting today–pay attention. 👇
NEXT UP
-
ISM Manufacturing (June) may have inched higher to 48.8 from 48.5. Below 50 indicates contraction.
-
JOLTS Job Openings (May) is expected to come in at 7.3 million, slightly less than the prior month’s 2.391 vacancies.
-
Wards Total Vehicle Sales (June) may show a decline to 15.3 million from 15.65 million.
-
Fed speak: global banking heavyweights including Powell will sit on a panel today.
DOWNLOAD MY DAILY CHARTBOOK HERE 📈