A strong currency has been the official U.S. policy position on the dollar for the last three decades and is still the policy position. The benefits associated with being the de facto global currency are well known. But President Trump is transaction-oriented, and not beholden to taboos that he believes don’t serve his interests. His interest in this unused policy lever has aroused enough concern for the Treasury Secretary to reaffirm the strong dollar policy. However, Trump has been consistent in his criticism of how undervalued he considers the euro to be and was quick to target China as a currency manipulator on the recent drop in the renminbi. A move to proactively de-value the U.S. dollar would be the equivalent of the nuclear option for the administration. It would be a clear weaponization of the dollar and could set in motion an ugly currency war and a race to the bottom.

Capital markets have reached critical levels in recent weeks. European bank stocks are on a ledge that has supported them since the Great Financial Crisis. Breakeven inflation rates in the U.S. are breaking lower to levels last seen in 2016. Copper is also back to 2016 levels and commodities in general continue to erode. There is a lot of uncertainty in the world apart from the trade discussions between China and the U.S.

Policymakers are approaching a fork in the road where something has to give. The one thing no one is expecting at this stage is a trade deal. The Chinese seem dug in and have prepared the country for difficult times. President Trump has been saying of late that the economic weakness associated with the tariffs is a price worth paying to get to fair trade. Resignation that you are not going to budge is exactly what each protagonist would like its opponent to believe. The biggest surprise would be the announcement that both parties had come to some terms, which would take all the pressure off the administration from resorting to the nuclear option.

Francis Scotland is the director of global macro research for Brandywine Global Investment Management. This article originally appeared in Brandywine Global’s Around the Curve blog and should not be reproduced without permission.

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