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Investing.com - The strength of the US dollar has been impacted by the sharp selloff in US stock markets as investors digested the potential impact of US tariffs on global growth, and Nomura discusses the likely scenarios given the broad dollar theme could be changing.
The Japanese financial house takes a look at a couple of scenarios.
Firstly if the US equity sell-off remains intense and continues in the coming weeks (e.g., Nasdaq is down ~20% or more from the peak).
This could lead to a weaker USD, analysts at Nomura said, in a note dated Jan, 28, as the market could begin to price in more rate cuts by the Fed in the near-term and through this year.
The risk is that not only will the incremental flow into US equities stall, but there is the emergence of sharp net foreign selling. There is a significant risk that the weakness in equities and downside US macro risks could lead Trump to be more focused on stimulating the economy (pressuring the Fed to cut and possibly increase fiscal spending) and stabilizing the equity market rather than imposing broad tariffs on the world.
It is possible that tariff risk on China could also fall, but there is still likely to be significant targeting of China from numerous angles, as highlighted in Trump’s America First Trade Policy.
If the US economy is weaker and the USD is softening, there is a risk that the market will begin to focus on the US twin deficits, global FX diversification, and USD FX overvaluation (~20%).
In the scenario of a more gradual decline in US equity prices in the coming weeks (e.g., Nasdaq down ~10% from the peak), that may not be enough to shake market expectations of US exceptionalism.
A mild correction in the equity market could marginally increase Fed cut expectations in 2025 (and possibly in the near-term), but this will likely be limited and possibly offset by impending Trump tariffs.
Without a significant sell-off in US equities, Trump is likely to move forward with tariffs following his success with Colombia, the confirmation of his key cabinet members, and consistent threats of action in the near term.
The risk under this scenario is the US exceptionalism theme and stronger USD continues with the combination of US growth outperformance, sticky inflation, the Fed struggling to ease policy, and the eventual implementation of US tariffs.