Why Trump's Midterm Rebuke Won't Likely Tank The Buck

A big part of this story is how Chairman Kevin Warsh's arrival at Fed headquarters in May isn't playing out the way Asia hoped. So far, Warsh has run the US central bank notably more hawkish than Trump assumed - at least so far.

He could still be biding his time before doing the president's bidding. But with US inflation running at 3.7% – a big factor in Trump's party's defeat on Tuesday – and the labor market holding up far better than expected, Warsh faces a complicated inheritance.

All of this is making life more challenging for the Bank of Japan. Markets are pricing in Fed tightening by year-end have Tokyo in a whirl. A hawkish Washington will pull capital toward US Treasuries, threatening the Nikkei's bull run - and the weak yen that juiced corporate profits now leaves Japan exposed to surging import costs and even higher inflation.

Japan is already grappling with stagflation. Growth is tracking at just 0.7% in 2026, while inflation is running about 2%. Given those headwinds, September's BOJ rate hike to 1%, a 31-year high, may be the last for a long while. A BOJ on hold while the Fed tightens is a near-perfect recipe for renewed yen freefall.

Nobody knows where the Warsh Fed lands six months from now - or how Trump, who tried to fire predecessor Jerome Powell and have him indicted, reacts if his chosen dove fails to deliver rate cuts. But the dollar surging amid a Fed tightening cycle wasn't on Asia's 2027 worry list. It is now.

HSBC economist Frederic Neumann argues that monetary officials will remain“on guard in Asia” because“a bouncy US dollar means that there is little reprieve for now.” A surging dollar, he said, makes“everything worse, threatening to suffocate Asian currencies and leaving governments across the region scrambling to sandbag their financial systems.”

The case for caution with dollar optimism, though, is long and growing. Here are seven reasons why dollar optimism may be misplaced.

One, politics. The US political system has not recovered from President Donald Trump's 2021 attempt to overturn his loss to Joe Biden, and the chaos around this election is likely to cloud policy direction for months.

Two, oil and the Middle East.“For the US dollar, oil remains the most important near-term driver to watch and any outsized move there will more than likely supersede any midterm impact,” said Sarah Ying, head of foreign-exchange strategy at CIBC.“We like positioning for US dollar downside, given that the US administration has taken a more conciliatory tone on Iran in recent days.”

Three, the Fed. Policy may be less aggressive than markets expect. Kevin Warsh, Trump's latest pick for Fed chair, could argue that lower rates are needed to stabilize the US economy. That would anger the“bond vigilantes” and narrow rate differentials, pushing capital toward Europe, Japan and emerging markets.

Four, growth. US growth will probably lag the rest of the world in 2027, thanks to tighter Fed policy and Trump's tariffs. That is not a recession call. But with China stabilizing, Europe's industrial recovery gaining traction, the Bank of Japan slowing its rate hikes and emerging markets holding their own, investors have reasons to rotate elsewhere.

Five, the AI trade. Most recent capital inflows into the US are tied, directly or indirectly, to AI, and the debt taken on by US tech giants has swelled 90% in six months to $3.2 trillion. If returns disappoint and valuations fall, the dollar loses its footing.

Deutsche Bank's George Saravelos notes that the boom cuts both ways: foreign buying of US stocks now funds the entire US current account deficit, yet roughly 90% of the $20+ trillion in US equities held by foreigners reflects price appreciation, not new buying.

Six, twin deficits. Washington has long gotten a pass, even with the national debt above $40 trillion, thanks to the“exorbitant privilege” of issuing the world's reserve currency (a phrase coined in the 1960s by French Finance Minister Valéry Giscard d'Estaing).

For now, it's a confidence game: the US can run large current-account deficits and a deeply negative net international investment position only while global investors keep financing it. If confidence wanes, the dollar could face pressure unseen since the 1970s, and Treasury yields could climb past levels not seen since the early 2000s.

Seven, the wildcards. The dollar could get another leg up if markets turn risk-on, whether because AI-bubble fears prove exaggerated or because Trump winds down the Iran war or eases tariffs.

Japan is the opposite wildcard. After decades of exporting capital in search of yield, Japanese institutions may bring money home as the BOJ shrinks its balance sheet and domestic yields rise.

Standard Chartered's Steve Englander argues that higher JGB yields make the yen more attractive, and that its low beta, low valuation and restored yield could help it if risk-off conditions come from asset markets rather than oil.