A Trump Risk Premium in the Dollar

Most blame the falling Dollar on a Trump risk premium, but there's no evidence of that

The standard rationale for why the Dollar has fallen so sharply - it’s down 11 percent so far this year - is that chaotic policy making by the Trump administration is causing a risk premium to build. Here’s the thing: there’s no empirical evidence that this is in fact what’s going on. Instead, the fall in the Dollar maps almost entirely into interest differentials. This means markets are trading a much more conventional view, which is that tariffs will drag down US growth, causing the Fed to be more dovish than other central banks. As I’ve noted previously, I disagree with this view. Even if there is a hit to growth, tariffs are inflationary for the US and deflationary for everyone else. That should keep the Fed more hawkish than its G10 peers, not more dovish.

My readers will be familiar with the left chart above, which shows the trade-weighted Dollar against the G10 (black) and the 2y2y forward trade-weighted rate differential of the US against the same set of countries. It’s tempting - looking at this chart - to think that a Trump risk premium is building, because the Dollar is down more than the rate differential. But looking at “levels” is misleading in this regard, because it compounds a bunch of moves that have nothing to do with the Dollar.

The right chart uses the same data, but looks at daily changes in the rate differential (horizontal axis) and the Dollar (vertical axis). I differentiate between pre- (black dots) and post-inauguration (blue dots) data points and highlight the last observation (Jun. 30, 2025) just like I do in the left chart. Three points emerge from this chart. First, as expected, there’s a positive link between the rate differential and the Dollar. Things that make markets think the Fed will be more hawkish make the Dollar go up and vice versa. Second, there is no discernible difference between pre- and post-inauguration data. Things have gotten noisier - no question there - but the positive link is basically the same. Third, yesterday’s fall in the Dollar, which had many people talking about a Trump risk premium, is very much in the middle of the distribution, which argues against a risk premium being behind yesterday’s fall in the Dollar.

Like it or not, the fall in the Dollar is about rate differentials, i.e. is about whether tariffs make the Fed more dovish or hawkish versus its G10 peers. This is just bread and butter macro. No need to get all touchy-feely about risk premia.