Escalating trade war could negatively affect the dollar for the long-term

Worries of escalating international trade wars could be a longer-term negative for the dollar, even as the currency gets a temporary lift ahead of the Fed’s meeting next week.

The dollar is seeing some support as the markets anticipate that the Fed will raise interest rates by a quarter-point next Wednesday. But the dollar has also been buffeted by other headlines, including threats of a trade war with China and a tumultuous reshuffling of Cabinet members, with Secretary of State Rex Tillerson the latest to leave, the announced departure of top economic advisor Gary Cohn, and others rumoured to be fired soon by President Donald Trump.

The dollar was mixed Friday, higher against the euro and many other currencies but lower against the yen. The dollar should be supported just by the fact the US is ahead of other central banks in normalizing interest rates.

Four Fed rate hikes this year instead of three would be positive for the dollar. But that sets up a tug of war between the Fed tightening and the negatives of potential protectionism.

Trump has imposed tariffs on steel and aluminium imports from many countries, and his administration this week threatened tariffs on $60 billion in Chinese goods.

Bank of America Merrill Lynch strategists in Europe released results of a global survey of 66 fund managers, who said the immediate reaction of building US trade tensions would be lower stocks and a lower dollar. On the other hand, the same survey showed that 42 percent of the fund managers believe central bank policies will be the biggest driver of the dollar this year, while just 11 percent thought trade issues would be.

Europe has already threatened tariffs on blue jeans and bourbon.

More worrisome than a US EU trade war is what reaction could come from China. A trade war with China would be a negative for the dollar and send investors into the safety trade in the yen.

A longer-term worry for the dollar is that a protectionist US could mean it loses some of its status as a reserve currency, with the yen and even euro looking more attractive.