The dollar is the 'collateral damage' of Trump's foreign policy

Reuters

Republican presidential candidate Donald Trump speaks on the USS Iowa in San Pedro, Los Angeles, California, United States September 15, 2015.

• The US dollar has risen about 4% over the past three months.
• Volatility is on the rise as Trump breaks with diplomatic norms.
• One analyst called the dollar "collateral damage" to Trump's foreign policy approach.

The US dollar has rallied about 4% in recent months, and investor sentiment for the currency is the strongest in years. But some analysts say that's all about to change as President Donald Trump ratchets up tensions between the US and its closest allies.

Mark McCormick, head of North American FX strategy at TD Securities, said in a research note out Monday the rally looks likely to roll over amid the return of the "Trump discount."

"The dollar is merely collateral damage to Trump's stressing of the global orthodoxy," McCormick said. "Geopolitical uncertainty is here to stay. The consequence is the market will be plagued by more volatility and bigger drawdowns, especially in the highbeta space."

Trump over the weekend refused to sign a joint statement with the US's closest allies following the Group of Seven summit in Quebec, which he left a day early to meet with North Korean dictator Kim Jong Un. And it was just the latest in a string of breaks from diplomatic norms that the president has led since taking office.

McCormick thinks this approach could create a "feedback loop" of sorts. The US needs an injection of foreign capital to fund its twin deficits at a time when assets might start to build a larger risk premium, he said.

The Federal Reserve on Wednesday is expected to raise its benchmark interest rate, which generally pushes the currency higher, but the effect could be softer than usual amid geopolitical tensions.

"For once, the Fed is more likely a sideshow than a primary driver in the FX markets this week," McCormick said.

On the other hand, some see the president's approach to foreign policy as an opportunity for a stronger dollar. Jameel Ahmed, head of currency and market strategy at FXTM, said hope for successful US-North Korea negotiations could bolster the greenback.

"For all of the unpredictable moments that have occurred since Trump became President of the United States, the news that he would have a summit with Kim Jong-un is perhaps the most significant," he said. "The USD could even catch a bid and move higher on optimism that Trump's foreign policy tactics could encourage world peace."