The political comeback of Donald Trump last week has not only shaken up the American political establishment but also caused a surge in the value of the U.S. dollar. This was somewhat unexpected, given that the financial industry expressed caution about a Trump return to the White House.
Nevertheless, the dollar is rising, especially vs. the euro, and there is no immediate reason to believe that it will come back down again. This could in fact be the very first sign of an emerging new balance in the long-term relationship between the American and European economies.
Before we get to the broader aspects of the market movements since Trump was elected, here is a quick rundown of where the dollar-euro exchange rate is. Figure 1a reminds us of how many dollars you have been able to buy for one euro in the past ten years:
Figure 1a
There are two phases in the euro-dollar exchange rate. From the euro’s minting until mid-2022, the rate fluctuated roughly around $1.10-1.15 per euro but exhibited a fair amount of volatility. After mid-2022, the exchange rate stabilized at approximately $1.08 per euro, with much more subdued fluctuations.
As Figure 1b reports, that stability seems to have been upset by the election last week:
Figure 1b
We should not draw too many implications from the strengthening of the dollar since November 5th, but we should also not dismiss it as a normal market fluctuation. To begin with, as Figure 1a shows, the euro-dollar exchange rate has been amazingly stable over the past couple of years. This kind of stability does not end for random reasons; buyers and sellers in the market for the U.S. dollar will cause a new exchange rate trend if and only if that new trend is more profitable than the current one.
In plain English, a stable exchange rate—like the one since 2022—brings great benefits in terms of economic predictability. Uncertainty is costly; a lower level of uncertainty means lower costs of business operations. A new trend in the exchange rate disrupts the low-uncertainty trend because investors see more profits associated with a strengthening dollar than they do from a continuation of the stable exchange rate trend.
The big question, of course, is where those profits would come from. Since the rise of the dollar was clearly triggered by Trump’s election victory, the benefits to buyers and sellers of U.S. dollars must be derivatives of that election victory.
Except for the usual speculation in marginal profits that occur on all markets, none of the profit derivatives from Trump’s election victory are short-term in nature. They are all long-term.
1. The U.S. debt market.
This may seem like a technical point, but it has an important consequence for the American economy. As the dollar has surged, interest rates on the federal government’s debt securities have gone down. This has been especially visible on short-maturity Treasury bills. Although the decline in rates is not major, it has changed the balance between short- and long-term Treasury securities.
Since 2021, interest rates have been lower on long-term securities, which is counter-intuitive to how these markets normally work. The new trend is restoring the ‘natural’ balance with lower short-term rates.
It is likely that investment money is flowing into the Treasury debt market because investors feel more optimistic about the U.S. government’s ability to end its endless budget deficits. Although President Trump was no deficit hawk in his first term in 2017-2021, he has shown at least some interest in reining in government spending this time.
One tangible example is his proposal for a new Department of Government Efficiency, DOGE. The purpose of this department will be to slim down the bureaucracy across the federal government, to streamline spending programs, and to eliminate wasteful practices in general. The DOGE will be led by two successful businessmen, Elon Musk and Vivek Ramaswamy which, from a business and taxpayer viewpoint, conveys a serious intent behind the idea.
It remains to be seen how much spending reductions can come out of DOGE’s work, especially given the fact that DOGE itself will need appropriations to operate. The big cost item for the federal government is not the employee payroll—it is the entitlements that hand out cash and in-kind services to eligible groups of people.
Nevertheless, with such tangible ambitions to put some kind of leash on government spending, Trump signals a new fiscal policy regime. He might be the first president since Bill Clinton who is seriously interested in holding back on government spending—and the first president on record to be willing to structurally reform government for this very purpose.
All this should give investors good reasons to want to invest in U.S. Treasury debt and its highly reliable interest payments.
2. Foreign direct investment
The movements we have seen in the last week in the euro-dollar exchange rate are not a sign of some new, substantial wave of foreign direct investment in the U.S. economy. However, they could be a sign that foreign companies are preparing for future investments in production facilities, corporate acquisition, etc., in the United States.
As I explained recently, with Trump as president it would be logical for European companies to increase their presence inside the U.S. economy. If Trump delivers on his promise to respond to European tariffs on U.S. products by reciprocating tariffs on European exports, the profit balance between traditional international trade and foreign direct investment suddenly shifts.
In short, at some point, the tariffs will make it cheaper to produce German cars in the United States for sale there than to produce them in Germany and ship them across the water.
Many European companies already have a substantial presence in the United States, including production facilities. However, tariffs on European exports would have ramifications for all of the EU, including countries whose businesses have traditionally not set up U.S. offices. It is entirely possible that we are witnessing a small wave of such investors trying to ‘get to know’ America before committing bigger resources.
If we are indeed witnessing the first signs of a major America-bound investment exodus from Europe, then Europe’s governments have all the reasons in the world to worry. Europe badly needs to keep its investors’ commitment to their home countries and their economies. However, if Europe has nothing to offer that can compete with what America is offering, then Europe has only itself to blame.
