Investors might be too optimistic about how quickly Trump can implement his policy agenda, even with Republicans in control of Congress and the White House. That could have a broad impact on markets.
It had seemed like nothing could stop the U.S. dollar from marching higher. Then a headline about President-elect Donald Trump's tariff plans landed in traders' newsfeeds, and suddenly all bets were off.
A Washington Post report published early Monday claimed the Trump team was exploring the possibility of narrower tariffs, focused on goods deemed vital to national or economic security, rather than the universal measures the incoming president had previously promised to impose on his first day back in the West Wing.
Investors greeted the news by dumping the dollar, sending the greenback toward its biggest one-day drop against the euro (EURUSD), its biggest rival, since Aug. 2, according to Dow Jones Market Data.
See: Report of easing tariff plan, which Trump denies, sends dollar lower
The dollar zagged higher once again when Trump denied the report shortly afterward in a post on Truth Social. But some market-watchers said the chaotic price action might offer an early glimpse at what could be in store for markets - not just currency markets, but stocks and bonds as well - as Trump's second term in the White House begins later this month.
"I think the market is very optimistically pricing in some best-case scenarios," said Michael O'Rourke, chief markets strategist at JonesTrading, during an interview with MarketWatch. "But translating that hope and that expected outlook to policy is so much harder."
Dollar's rally hits a speed bump
Monday's pullback hinted that cracks might already be forming in the dollar's recent rally, at a time when investors on Wall Street are almost universally bullish on the U.S. currency.
Both the dollar and Treasury yields have been climbing since the Federal Reserve delivered its first cut to its interest-rate policy outlook in September, with those gains accelerating after Trump's electoral victory on Nov. 5.
The ICE U.S. Dollar Index DXY, a popular gauge of the dollar's strength against a basket of rivals, touched its strongest level in more than two years late last week.
The rally has made equity bulls uneasy, with some blaming the dollar's strength for contributing to the latest hiccup in the stock-market rally. The S&P 500 SPX tallied a loss for the month of December.
In a client note shared with MarketWatch on Monday, Neil Dutta, an economist at Renaissance Macro, said the strong dollar was becoming "a problem" for the U.S. economy, corporate earnings and emerging markets.
Just like the move in yields, the dollar's strength isn't only being driven by expectations surrounding Trump's policy agenda - although that is certainly a factor.
In reality, the shift in bond yields in favor of the U.S. has likely given the dollar the biggest boost, said Brad Bechtel, global head of currency at Jefferies.
Rising yields have been driven by several factors. On the one hand, the strength of the U.S. economy relative to its foreign peers has made U.S. assets, and the dollar, more attractive to foreign investors.
But investors' uneasiness with the federal government's yawning budget deficit, coupled with expectations that the supply of Treasury bonds will only continue to grow, appear to have played a bigger role, RenMac's Dutta said.
Bechtel added that the dollar's latest run higher has been "very unusual." Historically, the fourth quarter of the calendar year has been a tough time for the greenback.
Going forward, Bechtel expects the buck could continue to climb through Trump's inauguration later this month. After that, investors will need to contend with the sometimes-messy policymaking process. At that point, the outlook for the dollar looks much less clear.
"There's a lot of nitty-gritty that goes into implementing a lot of these policies," he said. "We have no idea how that implementation is going to go."
The drama surrounding House Speaker Mike Johnson's re-election bid last week offered a hint that the Republican Party might not be quite as united around Trump's policy agenda as it might seem.
Right now, many on Wall Street are buying into the notion that Trump's aggressive trade rhetoric is merely a negotiating tactic, O'Rourke said.
But it is impossible to know for certain what Trump's intentions truly are, he added.
Add to this the constant push-pull of anonymously-sourced reports from news organizations, and this is starting to look like a recipe for more volatility across markets.
"Headlines going in both directions create volatility in a number of financial assets," O'Rourke said.
When it comes to Trump's trade agenda, there is another thing investors should keep in mind.
It is unlikely that the incoming administration will roll out all of its tariff plans in one fell swoop. More likely, Trump will use his executive authority to push through some trade-related measures, while leaning on Congress to push through others, said George Saravelos, global co-head of FX research at Deutsche Bank, in a note shared with MarketWatch.
"On tariffs specifically, we would emphasize that we should not be expecting one specific implementation approach or timeline; but that there are likely to be multiple overlapping legislative/executive initiatives with rolling deadlines/announcements throughout the year," he said in written commentary.
All of this could help to complicate how markets might react.
Wall Street is super bullish on the greenback
Indeed, it seems both Wall Street and futures traders are both extremely bullish on the dollar's outlook. Speculators of all stripes have ratcheted up their net-long position on the dollar to one of the highest levels in years.
On a trade-weighted basis, speculators' net bullish positioning in futures contracts tied to the greenback has reached its highest level since 2015, according to a Deutsche Bank analysis of data published by the Commodity Futures Trading Commission.
But such unbridled enthusiasm belies a common issue with markets: they rarely move in a straight line. The U.S. dollar had a strong showing in 2024. It is already trading at extreme levels last seen in late 2022. How much further can it realistically rise in the months ahead?
"I think the market is extremely bullish on the dollar. I don't know that I agree with it," Bechtel said.
Echoes of 2017
The buck's recent rise has also stirred up a certain sense of déjà vu.
Brent Donnelly, president of Spectra Markets, said in commentary shared with MarketWatch that a chart of the euro-dollar currency pair bears an uncanny resemblance to the price action from late 2016 and early 2017.
Back then, the dollar also saw a big run-up in late 2016 as traders cheered Trump's upset victory and the potential for his "America First" agenda. But then it sold off as the administration ironed out its policy priorities and investors contended with a revolving door of White House staffers and Cabinet members.
Of course, if Trump does follow through with plans to enact a 10% global tariff - or 25% tariffs on goods from Canada and Mexico, as he has previously threatened - then the buck would likely strengthen in response, Donnelly said.
Any further upside for the greenback would likely be contingent on Trump following through on his pledge for aggressive trade protectionism, Donnelly said.
"The onus on the newsflow is now to deliver some shock and awe, or bonds will rally, and the dollar will sell off," Donnelly said in commentary shared with MarketWatch late last week.
See: Stock market will find it hard to rally unless the dollar and bonds calm down
-Joseph Adinolfi
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