Trump 2.0: Tariffs, Trade, and the Dollar

25 September 2025

To be sure, financial markets have needed to react to a daily diet of consequential, and often quickly reversed, policy announcements during the early months of Trump 2.0. What has been consistent, however, has been the US dollar’s depreciation: the greenback has fallen 10% this year. Indeed, many had expected the dollar to appreciate, as countries attempted to regain the competitiveness lost from the imposition of US tariffs.

I have been surprised and impressed countries have not retaliated against the USA, perhaps in an effort to keep the global trading system in tact as much as possible. Therefore, did individual countries allow their exchange rates to appreciate in an effort to achieve a favourable trade deal with the USA? Or, have markets concluded the USA is more vulnerable to its tariffs than its trading partners. I will address investors’ concerns about the US dollar. Fundamentals point to further USD weakness. And, if global investors begin to question the credibility of US trade, fiscal, and monetary policies, even greater volatility may lie ahead.

Currency Manipulation: Is America a Victim?

To be sure, the dollar remains substantially overvalued, despite its recent decline (Chart above). However, the Trump team’s claim that countries are engaging in widespread currency manipulation to gain a competitive advantage is false. Indeed, many US trading partners also have overvalued trade-weighted exchange rates, e.g. Switzerland, Taiwan, and Thailand (Chart above). Likewise, the currencies of other major US partners appear fairly valued, e.g. Mexico, China, Euro, etc. On the other hand, Japan, Canada, and Brazil do enjoy considerably undervalued exchange rates.

Tariffs, Trade, and Economic Vulnerability

As most countries are more reliant on trade with the USA than the America is with them, the conventional wisdom has been that foreign nations were more vulnerable to an all-out trade war. Mexico, Canada, and many Asian countries, for instance, appear most at risk. The European Union, China, India, Indonesia are less so (Chart above). As most countries have accepted US tariffs without reciprocating, the competitive advantage the USA gained is even more pronounced.

However, US tariffs are a tax on American households and businesses amounting to nearly 1% of GDP. And, there is no evidence that foreign producers are cutting prices to offset the impact of US levies. As a result, the US economy has slowed sharply: GDP grew only 1.4% in H1 2025 compared to 2.8% last year. Predictably, weaker consumer spending has been the main contributor to the slowdown: rising just 1% during H1 2025 compared to 2.8% in 2024. So far, corporate profits and capex have remained robust, but I expect tariffs to take a toll on US profit margins in the period ahead.

Overall, I expect US GDP to grow only 1% in 2026. And, remarkably, European growth may exceed America’s next year. As Trump’s tariffs will hurt the US economy more than Europe’s and China’s, the US dollar will weaken further. Indeed, the Trump team will welcome this as part of its pro-growth agenda.

Presumably, Potus 47 anticipates higher tariffs will eliminate America’s trade deficit, which should help the US currency. But, quite the opposite is happening. Indeed, the US deficit has expanded to $834 billion through July compared to $674 billion last year. And, the red ink has increased with virtually every trading partner, except China. To be sure, the US external imbalance results from America’s appetite for foreign goods, not a lack of competitiveness. Therefore, tariffs will not correct the problem, and rising external deficits and debt will contribute to additional dollar weakness.

Meanwhile, despite its deep-seated domestic problems, China has been able to cope with higher US tariffs so far. Indeed, its trade surplus has soared to $785 billion compared to $609 billion last year. To be sure, China’s bilateral surplus with the USA has narrowed, as exports declined 16% (Chart above). However, China has successfully shifted trade to ASEAN countries, Africa, and Europe — reflecting double-digit export growth — and surpluses have soared. Similarly, confronted with US tariffs, other countries will also seek deepen trading relationships elsewhere.

Dedollarisation: Yes, But Slowly

Some have suggested the dollar may weaken as global central banks diversify the currency composition of their international reseserves. To be sure, the dollar’s share of FX reserves has been declining during the past decade (Chart above). So far, however, this transition has taken place gradually, and has not played an important role in the US currency’s performance. Indeed, the greenback remains dominant, but dedollarisation could accelerate if the credibility of US trade, monetary, and fiscal policies is undermined.

Likewise, some believe that Emerging Market currencies, especially the Chinese yuan, could play a bigger role in trade financing and reserve holdings. Again, so far, this has not happened, as the Euro, yen, and British pound have been the biggest beneficiaries of the diversification away from the dollar. Similarly, while central banks have increased their gold holdings in recent years, the bulk of these purchases have occurred only in China, India, Russia, Brazil, and the Middle East. European and Japan’s monetary authorities’ physical gold holding have remained quite stable. Gold’s price rally largely reflects investor and final consumer demand.

Capital Flow, Credibility, and FX Crises

As the United States will continue to run large current account deficits in coming years, the nation will need to attract foreign capital inflows to pay the bill. Fortunately, despite the recent chaotic policymaking, the attractiveness of US assets has continued to entice global investors (Chart above). Indeed, both portfolio and direct investments have risen sharply in 2025.

The US dollar’s prospects, therefore, will depend on whether global investors maintain a positive view on American growth prospects and US policy credibility. As I discussed earlier, I believe the US economy will continue to decelerate during the coming year. As a result, I expect S&P 500 EPS growth to fall far short of the lofty consensus forecasts of 11% and 13% in 2025/26 respectively. Indeed, I expect US equity returns to be only 4% in the next year — below outcomes in other global markets. Likewise, this year’s narrowing of bond yield differentials between the US and international markets has reduced the relative attractiveness of US fixed income investments (Chart above).

Already, the Trump tariffs have cast doubt on American reliability abroad. In addition, the Administration’s recent criticism of Fed interest rate decisions, attacks on Board members, and concerns about Chairman Powell’s future and who might succeed him have raised concerns about the Fed’s independence and the credibility of US monetary policy. Perhaps most worrisome is that President Trump’s Big Beautiful Bill left US fiscal policy on an unsustainable course. To be sure, the US is not alone, but the rise in American debt has been more dramatic than many other countries (Chart above). This combination of fiscal, trade, and monetary policies could undermine American credibility eventually, and pave the way for an even sharper decline in the US dollar’s value.

Strategic Implications:

  • The US dollar is likely to decline an additional 5-10% in the coming year. A loss of investor confidence in the credibility of US policies could lead to even greater volatility, although the timing of such events is difficult to gauge. Gold provides a valuable hedge.
  • Amid this year’s exchange rate volatility, each national currency has responded differently to the prospect of higher tariffs, which may lead to a wider disparity of FX movements in the period ahead (Chart above).
    • The Japanese yen, for instance, is very undervalued; consequently did not depreciate as tariffs rose 15%. To ward off future bilateral trade tensions, JPY may be the strongest G7 FX in the period ahead.
    • While negotiations have not been concluded, Canada and Mexico are amongst the most vulnerable to US tariffs. However, neither CAD nor MXN have deviated from last year’s performance. As MXN is not undervalued, it could depreciate considerably if a trade war breaks out. On the other hand, CAD is already cheap, and may be a bit less vulnerable (see early Chart for each currency’s over/undervaluation).
    • As exports to the USA are not large (as a percent of GDP), China is not particularly vulnerable to US tariffs. During the 2018 trade war, PBOC allowed CNY to depreciate. China may repeat the same strategy.
    • Export-oriented Asian countries are vulnerable to US levies. But, individual countries implemented different FX strategies to achieve favourable outcomes in trade talks. As Taiwan, Thailand allow their currencies to appreciate, TWD, THB, And MYR may become vulnerable now.
    • Switzerland now faces 39% US tariffs. As CHF is overvalued, it may weaken versus the Euro.
    • India and Brazil face punitive 50% tariffs. As each country has a large domestic market, they are less exposed to US tariffs. BRL is very undervalued, so risks are not great. INR will likely decline in line with its inflation rate, as usual.