In a move set to reshape the economic landscape, former President Trump's proposed tariffs could see the average effective tariff rate on all US imports soar from less than 3% to approximately 20%. This significant policy shift aims to strengthen the US dollar against foreign currencies, impacting both domestic consumer prices and international trade dynamics. Economists forecast that this tariff plan will add around 2% to US consumer prices, potentially boosting inflation to 4% by 2025, according to Paul Ashworth, chief North America Economist at Capital Economics. As the global market braces for this change, the implications for international currencies and trade relations are profound.
The US dollar has already shown signs of strength, with the Nominal Broad US Dollar Index hitting its highest monthly level on record in January. Economists anticipate further strengthening of the dollar in 2025 as a direct consequence of Trump's tariff policy. James Reilly, a senior markets economist at Capital Economics, noted the positive correlation between tariffs and the US dollar's value.
"Tariffs, all else equal, are good for the U.S. dollar." – James Reilly, senior markets economist at Capital Economics.
Historically, the DXY index saw a rise of up to 10% during tariff announcement windows in 2018 and 4% in 2019, underscoring the influence of tariffs on currency strength. The trade war with China in 2018-19 provides a glimpse into potential outcomes, as the dollar strengthened considerably during that period.
However, economists caution that retaliatory tariffs from trading partners may counteract this upward trend. A report by Bank of America analysts suggests that if global retaliation ensues and these trade policies adversely affect the US economy, the dollar could weaken later in the year. This sentiment is reinforced by recent movements in the Canadian dollar, where a tariff-induced spike saw the US dollar reach its highest level in over a decade against the Canadian currency in February 2024.
Looking ahead, a 25% duty on all steel and aluminum imports is slated to take effect on March 4, with additional tariffs on Canada and Mexico potentially following suit. Such measures are expected to bolster the US dollar while potentially weakening major currencies like the euro. In response, the European Central Bank (ECB) might consider cutting interest rates to stimulate their economy, according to Reilly. This would widen the interest-rate differential between the US and Europe, prompting investors to favor dollar-denominated assets over euro-based holdings.
The ICE U.S. Dollar Index (DXY) has climbed more than 3% since Trump's election day victory, reflecting investor confidence in the dollar amid anticipated tariff policies. This shift poses challenges for countries relying heavily on exports to the US, as their currencies could face depreciation pressures. Economists predict that while tariffs may initially strengthen the US dollar, sustained economic impact and international pushback could alter this trajectory.
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