The U.S. presidential election meaningfully changed the outlook for fiscal policy, with important implications for the U.S. dollar in the medium term. While we do not yet have details about the mix of tax cuts/reforms and spending that will make up the Trump administration’s proposals, all signs point toward a period of fiscal expansion designed to spur growth.

Read more:our overall global multi-asset outlook for 2017

Potential Impact of Fiscal and Monetary Policy Divergence

On its own, fiscal policy may not directly impact currency markets. Economic theory and history suggest, however, that fiscal stimulus is more likely to generate currency appreciation when fiscal and monetary policy diverge with the policy of other countries. Our policy outlook today, for example, is for fiscal expansion amid monetary tightening, while other developed countries remain in a phase of fiscal contraction. As noted in Exhibit 1, the closest historical analogy to today’s policy outlook comes from the Reagan Era, during which U.S. fiscal expansion diverged from other countries and the Fed was engaged in aggressive monetary tightening. This environment resulted in the strongest U.S. dollar bull market in history (see Exhibit 2).

Exhibit 1

The Outlook for fiscal Policy Divergence is Reminiscent of the Early 1980s

Exhibit 2

Fiscal Expansion Per Se Have Not Led to Dollar Strength

Corporate Tax Incentives May Also Boost the Dollar

Further, the potential under the Trump administration for deep corporate tax cuts and incentives for companies to move production to the United States may also lend strength to the greenback. In the short term, the dollar may benefit from anticipated stronger equity inflows as repatriated earnings are paid out to shareholders. In the long term, corporate tax reforms could lead to a structural improvement in the U.S. trade balance and to net foreign direct investment flows.

Although the U.S. dollar appears somewhat expensive today, the projected fiscal policy could lead it higher. We believe that there is room for an additional 5%-10% appreciation should the Trump administration’s proposals come into effect.

Our paper offers more about the direction of U.S. fiscal policy and its potential impact on the dollar.

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