Robin Brooks, Silvia Ardagna and Michael Cahill, currency strategists at Goldman Sachs, remain unabashed US dollar bulls in the wake of Donald Trump being elected as the next president of the United States, saying in a note released on Thursday that the US dollar is likely to gain a further 7% on a trade-weighted basis over the next three years.
The basis for their call is simple: an acceleration in inflationary pressures in the United States will see interest rates rise at a far quicker pace than markets currently expect.
Here’s why the trio believe that no matter what happens, inflation is now likely to be far higher under a Trump presidency:
There is upside risk from the fiscal stimulus, while there is downside risk from an escalation in protectionism. But in either case, inflation is likely to be higher than before, which is what has probably helped drive inflation breakevens up. As a result, market pricing for Fed hikes has risen sharply, with tightening priced through September 2019 now 86 basis points, almost a full hike more than at points before the election.
Our point here is not that risks don’t exist. Of course they do. Instead, it is that the policy mix has shifted in the direction of more inflation, which means that – given how dovish market pricing has been – there is room for the Dollar to catch up with where it should have been quite some time ago.
Our US team forecasts three hikes next year in addition to the one now likely in December. This is more than double what is priced and underpins our forecast for the Dollar to rise around 7 percent on a trade-weighted basis over that horizon.
Essentially, Goldman says that policy under Trump will “reset” the US dollar rally that began in earnest over two years ago.
Beyond the four 25 basis point rate hikes Goldman’s economics team believe the Fed will deliver before the end of next year, it forecasts that the Fed funds rate will sit at 3% by the end of 2019.
If that occurs it will certainly support the US dollar.
However, it’s a very aggressive call, particular given the Fed has only delivered one solitary rate hike in more than a decade.
Here’s a chart of the US dollar index going back three years:
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