Thoughts on the Market: What Will Tariffs Do to the U.S. Dollar?

Hosted by Morgan Stanley | Released on March 4, 2025

Introduction and Context

In the March 4, 2025 episode of Thoughts on the Market, Morgan Stanley's Ariana Salvatore and Andrew Watros delve into the dynamics surrounding the U.S. dollar amidst the early days of the new Trump administration. The episode centers on the impact of recently implemented tariffs and evolving fiscal policies on the dollar's dominance in global markets.

USD Dominance in Global Markets

Ariana Salvatore opens the discussion by highlighting the significance of the U.S. dollar in global finance, noting the recent imposition of substantial tariffs: “Last night at midnight, 25% tariffs on Mexico and Canada went into effect, in addition to 10% on China” (00:09). Andrew Watros underscores the dollar's entrenched position, stating, “The US dollar is used in about $7 trillion worth of Daily FX transactions. And the dollar's share of all currency transactions has been pretty stable over the last few decades” (00:43). He further emphasizes the dollar's dominance in trade finance: “Something like 80% of all trade finance is invoiced in dollars.”

Comparison with 2017: Factors Influencing USD

The conversation shifts to a historical perspective, comparing the current scenario with the first year of the Trump administration in 2017, when the dollar experienced a decline. Andrew explains, “In 2017 gets a lot of client attention because the Fed was hiking, there was a lot of uncertainty about what would happen in NAFTA and the US Passed a fiscally expansionary budget bill that year” (01:07). He identifies three primary reasons for the dollar's downturn despite these factors:

1. NAFTA Uncertainties: “US Tariffs didn't actually go up” despite headlines suggesting potential NAFTA departures.
2. Global Growth Strength: “Global growth turned out to be really strong in 2017... aided by fiscal policy and growth in China and Europe.”
3. European Political Risks: “Political risks in Europe that didn't end up materializing,” alleviating investor concerns over a potential Eurozone breakup.

Andrew concludes that these factors collectively contributed to a weaker dollar in 2017, which later reversed in 2018 as conditions changed (02:07).

Current Fiscal and Trade Policies Under Trump Administration

Ariana contrasts the current policies with those of 2017, highlighting nuanced differences. She remarks, “Tariffs and tax policy were a big focus in 2017-2019... but in a slightly different way” (03:06). Key distinctions include:

• Broader Tariff Scope: Unlike the past focus primarily on China, the current administration has levied 25% tariffs on Mexico and Canada, starting at a higher rate than the previous 25% on Chinese goods.
• Sequencing of Policies: Previously, tax cuts preceded trade tensions. Currently, the administration is “really the inverse” with trade policy being a priority even before passing the budget resolution for tax cut extensions.

Ariana further explains the fiscal landscape, noting the passage of a budget resolution in the House aimed at extending the Tax Cuts and Jobs Act (TCJA). However, she cautions that “there are some key sticking points in the discussion,” including disagreements over the SALT cap and potential clawbacks from the Inflation Reduction Act, which could delay consensus until the end of 2025 (04:47).

Impact on the U.S. Dollar and Market Expectations

Andrew Watros draws parallels between the current fiscal developments and those of 2017, suggesting that the dollar might experience a similar decline before potential recovery. He states, “We think that compared to 2017, there's a lot more US dollar positive risk premium around trade policy” necessitating a higher threshold for the dollar to appreciate from trade-related news alone (02:16). Additionally, he points out that European fiscal expansions and anticipated Federal Reserve rate cuts pose headwinds for the dollar.

Dissecting the impact of fiscal policy stages, Andrew reflects on past patterns: “One lesson from 2016 to 2018 is that there were really two stages of when fiscal developments boosted the dollar” (05:53). The initial rally followed the election and TCJA passage, but the current scenario suggests a delayed boost contingent on tax cut extensions, leaving room for the dollar to weaken in the interim.

Equities vs USD Dynamics

Ariana shifts focus to the interplay between fiscal policies and the equity market, particularly how tax changes might influence specific sectors such as industrials, healthcare, and telecom. She inquires about the relationship between equity performance and dollar movements, to which Andrew responds by revisiting historical trends:

“In 2016-2018 the US dollar did not trade in line with yield differentials. Instead... equities were a much better barometer” (07:58). He notes that, similar to 2017, current equity movements outside the U.S. are catching up with or outperforming U.S. stocks, suggesting that the dollar may decline as it did when international equities rallied (08:57).

Potential Triggers for USD Appreciation

Addressing what could reverse the dollar’s downward momentum, Andrew cites lessons from 2018: “If trade tensions evolve in a direction where our economists significantly downwardly revised their global growth forecasts, then the US Dollar could start to look more attractive as a safe haven” (09:10). Additionally, he mentions that significant increases in long-term treasury yields, although not currently expected, could also bolster the dollar’s appeal.

Conclusion

As the episode wraps up, Ariana and Andrew illuminate a nuanced forecast for the U.S. dollar amidst expansive tariff implementations and ongoing fiscal policy negotiations. While historical comparisons to 2017 suggest potential decline in the dollar's value due to broader trade policies and delayed fiscal benefits, external factors like European fiscal shifts and unexpected treasury yield movements could alter this trajectory. Investors are advised to monitor these evolving dynamics closely as the administration navigates through its economic agenda.

Notable Quotes

• Andrew Watros (00:43): “The US dollar is used in about $7 trillion worth of Daily FX transactions. And the dollar's share of all currency transactions has been pretty stable over the last few decades.”

• Andrew Watros (01:14): “[There are] three reasons why the US Dollar went down despite all those factors... NAFTA tariffs not increasing, strong global growth, and unresolved political risks in Europe.”

• Andrew Watros (02:16): “We think that compared to 2017, there's a lot more US dollar positive risk premium around trade policy.”

• Andrew Watros (05:53): “One lesson from 2016 to 2018 is that there were really two stages of when fiscal developments boosted the dollar.”

• Andrew Watros (07:58): “In the initial years of President Trump's first term, equities were a much better barometer than interest rates for where the US dollar would go after President Trump was elected.”

• Andrew Watros (09:10): “If trade tensions evolve in a direction where our economists significantly downwardly revised their global growth forecasts, then the US Dollar could start to look more attractive as a safe haven.”

Timestamp Reference

• MM:SS

Note: All timestamps reference the provided transcript for accurate quote placement.