The U.S. dollar's strength poses the biggest threat to the prevailing market consensus that president-elect Donald Trump can lift the U.S. economy's growth trajectory, said Mohamed A. El-Erian, chief economic adviser at Allianz.
In a keynote speech at Hong Kong's Asian Financial Forum on Monday, Mr. El-Erian said Mr. Trump's recent focus on pro-growth tax cuts and infrastructure spending, capable of being enacted by a Republican-controlled Congress, while de-emphasizing talk of protectionism have strengthened the consensus that upside risks will be more pronounced in 2017.
An overly strong dollar is “the major risk” to that scenario, said the former CEO of Pacific Investment Management Co., Allianz's fixed-income subsidiary.
If Mr. Trump's policies succeed in boosting growth, the U.S. economy will attract more capital and the Federal Reserve will hike rates faster, both of which will support further dollar strength, he noted.
That strength could further fuel protectionist sentiment in an environment where low growth and a highly skewed distribution of income has spawned a “politics of anger” and raised the specter of highly unpredictable outcomes, Mr. El-Erian said.
He cited the sharp decline in the value of the Mexican peso since the U.S. presidential election as an example.
While that decline was driven by Mr. Trump's campaign rhetoric about trade deals that allowed U.S. manufacturers to shift production – and jobs – south of the border, Mexico “has gained competitiveness” as a result, raising the prospect of further anti-trade rhetoric in the U.S., said Mr. El-Erian.
Mr. El-Erian said things should come to a head within the next two years, with politics rather than economics as the likely trigger.
“We are going to tip,” and the worse of two roughly equivalent possibilities is that the U.S., the U.K. and other countries slip into anti-trade, inward-looking nationalistic policies, he said.
That option will raise the risks of going “from low growth to recession, from artificial financial stability to unsettling financial volatility,” he said, noting that politics will get “a lot messier.”
The happier option is that this “endogenous disruption to the political system” prompts that system to respond to the “anger that's out there” with constructive policies, including pro-growth structural reforms in areas such as tax and labor market reforms, a greater reliance on fiscal policy, debt forgiveness and strengthening economic and policy architecture in Europe and globally, said Mr. El-Erian.