The recent tariff and tax policy introduced by President Trump is causing a ripple effect in global financial markets. The dollar is under pressure, investor confidence is shaking, and international investment in the U.S. is declining. These changes may signal that the Federal Reserve and the Treasury are entering a new policy dilemma.
Dollar Marks Worst Performance Since Start of Year
According to Dow Jones market data, by the end of May, the dollar index had fallen 8.4%, marking the worst performance in the first five months of the year on record. The current index is approaching the low point of spring 2022. This index tracks the dollar against a basket of six major currencies, including the euro, pound, and yen.
Although there are no signs of a sharp deterioration in the U.S. economy, the continued depreciation of the dollar largely reflects external investors' concerns about the U.S. policy environment. The Trump administration's successive tariff adjustments and punitive "Revenge Tax" have significantly increased the risks of foreign capital holding U.S. assets.
"Revenge Tax" Worries International Investors
What worries the market is the new "Section 899" clause included in the U.S. Congressional tax and expenditure bill, authorizing the government to levy additional taxes on investments from specific countries. These are usually regions whose tax systems are deemed "discriminatory" or "unfair" by the U.S.
For instance, European countries have long imposed a "digital services tax" on American tech giants, seen as non-tariff barriers to U.S. companies. According to the new clause, if European investors repatriate capital gains, interest, or dividends obtained from the U.S., they will face additional taxation, which undoubtedly increases their concerns about investing in the U.S.
John Hardy, Head of Global Macro Strategy at Saxo Bank, warns: "If this tax is applied broadly, it could curb the participation of foreign surplus capital in U.S. markets, especially against the backdrop of a surging U.S. deficit, representing a structural blow to the dollar."
Global Currencies Rally, Dollar Shows Weakness
Despite recent interest rate cuts by the European Central Bank, Bank of England, and Bank of Japan, and their domestic economic slowdowns, these countries' currencies have generally strengthened: the euro has risen by 11% against the dollar, the yen by 9%, and the pound has also appreciated by about 8%.
In stark contrast, the dollar has entered a downturn against almost all mainstream currencies. The market widely believes that the U.S.'s recent aggressive combination of fiscal and trade policies is undermining the dollar's status as an international reserve currency and its asset appeal.
Pros and Cons of a Weaker Dollar
In the short term, a weaker dollar might benefit the U.S. export industry by enhancing the competitiveness of American products internationally and lowering the cost of repatriating overseas earnings for multinational corporations. However, from a more structural long-term perspective, the dollar's depreciation could pose deeper systemic risks.
The U.S. has long relied on foreign capital to maintain its large trade and federal deficits. According to the Congressional Budget Office, by 2035, U.S. federal debt could surpass $50 trillion. Sustaining foreign capital inflow is key to supporting U.S. stocks, stabilizing Treasury yields, and maintaining the dollar's credit system.
However, if the Trump administration continues to push for "punitive" international tax and tariff policies, it could accelerate the "de-risking" process of foreign funds from the U.S. market, plunging the dollar into a deeper depreciation cycle.
