This week, the U.S. dollar trade-weighted index fell to lows not seen since 2014. As we’ve discussed here before, that might seem strange considering we are seeing the stock market hit new highs nearly every day.

A lot of those stock market gains are the result of better earnings guidance that was bound to follow the passage of major tax reform legislation.

But still, it would seem that the increased confidence in U.S. growth that is coming from economists should give the U.S. dollar a boost. Bond yields are also moving in favor of the greenback, particularly on the short end, as U.S. 2-year treasury yields crossed the 2 percent mark for the first time since the Great Recession. And 10-year yields traded north of 2.6 percent this week - at highs not seen since March 2017.

And yet, we still continue to see a weakening dollar.

What’s going on? There are a couple of factors at play.

  • Oil prices have been rising. And since oil prices around the world are usually denominated in dollars, there typically has been an inverse relationship between the two.

That has been especially true over the last few years, as this chart shows:

  • It could also be that the chatter around U.S. trade policy and concern over geopolitical strife is finally starting to hit home with currency markets. In addition to the obstacles we discussed last week around NAFTA, there is increasing tension between the U.S. and China over the review of potential steel tariffs. And there is also some tension around our trade treaty with South Korea.  

The reality is that when President Trump withdrew the U.S. from the Trans-Pacific Partnership and the Paris Climate Change Treaty, there were no existing business structures associated with those nascent agreements that could potentially be adversely affected.

In contrast, exiting NAFTA or other legacy trade agreements would cause widespread business disruption.

My View: The drivers of dollar valuation have clearly changed from being an interest rate story to a commodity story. It’s possible that trade policy decisions are starting to play a bigger role: While the Republican Congress and the administration were roughly united on tax policy goals and other agenda items in 2017, it is fair to say that significant Republican opposition exists to the idea of scuttling established trade deals. What is still left to determine is whether looming political fireworks on that front will add to the dollar dynamic going forward.

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