Why Trump’s trade war threats are battering the US dollar

Since U.S. President Donald Trump began threatening a trade war last week, the U.S. dollar has fallen against its major developed market peers.

The dollar index, which measures the greenback against a basket of currencies fell as low as 89.407 on Wednesday evening Singapore time, down from levels above 90.6 before Trump’s threats.

Capital Economics said in a note dated Tuesday that currency market reactions to Trump’s proposed tariffs on steel and aluminium imports suggested that investors were “far more concerned” that this marked the start of a trade war, with potentially severe economic fallout, than any direct effects.

It noted that emerging-market currencies have largely fallen against the dollar even though the impact of the proposed tariffs in emerging market economics was likely to be small for almost all of them, suggesting investors were retreating from risky assets in general.

The proposed tariffs might have been expected to boost the dollar against major economies’ currencies, as well as emerging markets’, as the duties would reduce U.S. demand for exports from those countries, Capital Economics noted.

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However, “investors appear to have concluded that a marked shift towards protectionism in the U.S. would ultimately see its economy fare worse than those of other developed countries,” it said, noting safe havens the Japanese yen and the Swiss franc have performed “particularly well.”

If a full-blown trade war breaks out, Capital Economics said it wouldn’t be surprising for the dollar to continue to gain ground against emerging market currencies, while dropping against developed market peers.

“However, even if this outcome is avoided, there is a good chance that these trends will continue to some extent, regardless,” it said, forecasting a U.S. growth slowdown next year.

After the note was published, fears of a trade war were heightened after Gary Cohn, a top economic adviser at the White House, quit. He had been the leading internal opponent to Trump’s protectionist plans.

The departure marked a blow to hopes that Trump might be convinced to once again retreat from an extreme policy.