How will Trump's tariff policy affect the US dollar?

It has long been assumed that a second term for Donald Trump would be pretty volatile,and, so far at least, things are definitely playing out this way. This creates numerous problems; one of which is that financial markets could become unplayable.

At this rate, the only beneficiaries of the pretty chaotic start to President Trump’s second term in office will be those with long-volatility positions. If we think about the euro/US dollar, for instance, the US dollar is still having some difficulty breaking out of the 1.05-1.10 range that has seen most of the action over the past two years. But while this period of range trading through much of 2023 and 2024 was accompanied by low volatility, recent times have seen volatility surge. If we take one-week implied volatility, for instance, much of 2023 and 2024 saw declining volatility with a low of close to 4% last spring and summer. But, as the election neared and then Trump won, volatility moved higher, and today it is close to 11%, nearly three times the low seen last year.

In other words, while the spot euro/US dollar exchange rate has not actually moved very much, this fear factor in the market means that implied volatility levels have surged. Looking ahead, it might remain the case that the US dollar goes nowhere, but in a very volatile way, as the currency responds to each and every policy surprise from Trump, as opposed to the situation for a good deal of Biden’s last two years when the US dollar was pretty stable, but in a low volatility environment.

But can we assume that the US dollar will track sideways, but in a more volatile way, if Trump’s policy pronouncements whipsaw the market, as we saw with his decision to delay tariffs on Mexico and Canada for a month? Steven Barrow, Head of Standard Bank G10 Strategy is not so sure. He feels that this policy to-and-fro could undermine the greenback for a number of reasons.

For a start, market positioning suggests that short-term speculative traders are quite long of the US dollar. Or at least this is the message of the data from the Commodity Futures Trading Commission’s (CFTC) weekly release. If, as seems likely, a good part of this reflects the anticipation that Trump’s tariffs will stick, then any sense that tariffs could become unstuck very quickly could weigh on the dollar.

A second factor is that confidence in US policymaking could decline markedly if policies are imposed and then unwound quickly. In the UK, the new Labour government has been accused of a similarly stumbling first few months, and that has seemingly weighed on UK growth prospects and the pound.

A third issue is that if US tariffs are imposed and then quickly unwound, there will be doubts that the policy can raise the sorts of revenues the administration may need to shrink the budget deficit. Of course, Trump does have the new Department of Government Efficiency (DOGE) to reduce spending, but if this involves things like the rapid closing of whole departments, as we’ve seen hints of already in the case of foreign aid, we may find that confidence in the administration is further eroded - and at a cost of a weaker US dollar. “Allied to this is the simple fact that high levels of uncertainty amongst US consumers and businesses can crimp activity. In this sense, we might argue that business confidence, in particular, would be best served by a clearly-defined long-term tariff strategy, than by the sort of on-off strategy that we may be seeing unfold at the moment”, said Steven Barrow.

One final point here, and we’ve made reference to it many times, is that the US dollar fell quite heavily in the first year of Trump’s 2017-2021 presidency. That period in office was also marked by similarly unpredictable policymaking as consumers and firms faced dealing with an administration the likes of which they had never seen before. Perhaps that uncertainty weighed on the US dollar early in the Trump presidency as businesses, consumers, and investors got used to the chaos. If we see a repeat this time around it may mean that if Trump continually flip-flops on his policies, particularly where tariffs are concerned, the US dollar is more likely to fall than rise.