How will USD move during the Biden years?

President Biden’s proposal makes good on his pledge to raise taxes on investment income for wealthy Americans.

When it comes to “ownership” or “control” of a currency, who is in charge, the government or the central bank? In theory, at least, it might seem that governments are the “owners” of the currency. After all, if the US decides to buy or sell its currency for intervention purposes, it is a decision that the government makes and the central bank is subservient to its wish. In practice, the relationship might not be quite so one-sided and if we look at some other places, like the euro zone there seems to be a more clearly defined role for the ECB to have an input in any intervention decisions.

Nonetheless, most would probably argue that governments are key when it comes to currency ‘ownership’ as also reflected in the fact that most central banks do not express an opinion about how they would like to see the currency move. Instead, they see FX moves as almost exogenous and hence their role is to be reactive to FX moves which might, for instance, mean adopting a tighter monetary policy if currency weakness threatens to lift inflation.

But if governments are in control it might seem a little odd that they can’t undermine the currency even when officials say things that might seem very negative. Former US President Trump said many things that we feel undermined the dollar. He called the currency overvalued, seemed to suggest that government default might not be such a bad thing and constantly tried to impinge on the Fed’s independence by telling it what it should do (which was primarily to lower rates). But none of these things seemed to unsettle the currency. Why was Trump’s invective ignored ? There were perhaps two main reasons.

The first was that Trump’s policies, particularly the large corporate tax cut, raised the attractiveness of the US, especially the stock market, and so undermined any verbal attempt to lower the greenback. In other words, its what political leaders do, not what they say that is important.

A second explanation is that it is not really the government that is in charge of the currency when it comes to the market’s psyche, but the central bank instead. The fact that the Fed managed to keep inflation under control during the Trump years meant that the dollar could not be undermined, even if Trump tried to make the Fed create much more inflation by slashing rates, and even if he more directly undermined the dollar by questioning its lofty levels and bemoaning the fact that the strong dollar was “killing us”.

Biden’s tax hike aspirations could undermine USD.

If we come back to today it is notable that two things could happen. The first is that the Biden Administration could lift corporate taxes (and some other taxes) back up again. The second is that inflation could take a grip, perhaps more permanently than the Fed and the markets anticipate. Straight away it occurs to us that these things could undermine the dollar, whether or not the Biden administration makes any Trump-like comments about the lofty values of the greenback. For if Trump’s tax cuts helped support the dollar; Biden’s tax hike aspirations could undermine it. And if the Fed’s stellar anti-inflation credibility through the Trump years kept the dollar firm, the current surge in inflation, coupled with the Fed’s own relaxed inflation target, could weigh on the greenback as well.

“At this stage, we don’t know whether Biden will be able to push tax hikes through or whether inflation will prove very sticky. All we would say is that there is a sufficient chance of both happening to make us feel that the dollar could be on shakier ground during the Biden years than it was during Trump’s ear-bashing presidency”, Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said.