Big Tax Cuts are Dollar Negative

FX traders tend to base every currency based on interest rate differentials, and the difference of the near term policy direction of the various central banks.  The generally accepted view is that big tax cuts which provide fiscal stimulus should strengthen the dollar, based on its effect on monetary policy.  It is assumed that you get tighter monetary policy with tax cuts.  But that overlooks recent history.  

One of the main reasons the Fed started QE in 2009 was because it wanted to lower the interest rate burden of the large budget deficits after the recession, because large Treasury supply was going to have to be taken down, and the only way that was going to happen was either by selling at higher yields or by having the Fed by a huge chunk of the supply.  If the market had to digest all that supply at higher yields, you would have had an absurdly steep yield curve, higher rates for corporations and small businesses to borrow at, and higher mortgage rates that would be a negative for the housing market.

With the rising trend in mandatory spending on Social Security and Medicare, the budget deficits are set to rise substantially anyway, without any tax cuts.  You add the proposed budget buster tax cuts to the mix, and you will see $2 trillion budget deficits within a few years.  That is why the market didn't skyrocket yesterday on the Trump tax cut plan.  Rising interest rates with low GDP growth don't mix.  And these tax cuts aren't going to do much for GDP growth, as it's mostly going to those who will pile it back into savings in the form of stocks and bonds, not consumption.  

So what will end up happening is the higher interest rates will more than offset any fiscal stimulus from lower taxes, and when you get the economy slowing down, the budget deficits will skyrocket and you will get huge amounts of Treasury supply coming down the pipe.  The Fed will react like they always do when the economy slows down in the face of rising interest rates due to excess debt:  they will lower them, and then do another QE.  

So these tax cuts will eventually lead to Fed rate cuts and then QE in a couple of years.  Which will lead to dollar weakness, not dollar strength.  Tax cuts are a long term negative for the dollar, due to the higher budget deficits and subsequent larger Treasury supply.  Just look at how the dollar performed in the years after Ronald Reagan's tax cuts in the 1980s and George W. Bush's tax cuts in 2001.  

So if you see any large tax cuts pass, keep this in mind when it comes to the dollar.

Dollar Index (43 year historical chart)