Donald Trump’s plan for the US economy faces this one big problem

The dollar’s appeal as a safe haven is driving ‘renewed and broad demand’ for the currency

PUBLISHED : Tuesday, 17 May, 2016, 11:28am
UPDATED : Tuesday, 17 May, 2016, 11:29am

April’s US jobs data came in below market expectations but their release on May 6, rather than triggering renewed weakness for the dollar, might prove the catalyst for the greenback to regain favour with currency market participants.

And that is without factoring what might occur in currency markets if there is a perception China’s economy might stall. An “L-shaped” trajectory for Chinese economic growth was the widely-reported opinion of an “authoritative figure” writing in last week’s People’s Daily.

Mr. Trump may yet have to accept that global circumstances could lend themselves to renewed and broad demand for the dollar

If China’s economy were to go “L-shaped” it would surely be reasonable to expect US government bonds and the dollar to be the beneficiaries of accompanying capital flows.

After all, in a general sense, the part played by a reserve currency such as the dollar “is to be a harbour during a storm, it’s where people flock when the unexpected happens,” as San Francisco Fed President John Williams said on May 9.

An “L-shaped” trajectory for Chinese economic growth would certainly be a tale of the unexpected.

As for the US economy, while analysts had expected April’s non-farm payroll (NFP) to show a rise of 200,000, the actual number printed at 160,000 and both the February and March figures were also revised lower. Market expectations for further hikes in US rates were pushed back.

It is also worth noting that the Fed’s own Change in Labour Market Conditions Index has given a negative reading every month so far in 2016, a four-month stretch of sub-zero data not seen since 2009.

But if the Fed concludes that domestic economic conditions do not justify a rate hike any time soon, that leaves room for other central banks to step in and ease their own monetary policy and arguably leaves the dollar looking relatively more attractive.

The Reserve Bank of Australia cut its benchmark rate to an all-time low of 1.75 per cent on May 3, but surely now has more room to cut if the Fed proves to be on hold.

In that circumstance and especially if the economic outlook for China turns cloudier, it would be hard to see how the Australian dollar could hold up versus the greenback.

In truth, Australia’s economically significant commodity sector long ago hitched its wagon to China. If China sneezes, Australia catches a cold.

It will not have gone unnoticed in Australia that, in April, China’s overall imports fell 10.9 per cent compared to a year earlier, dropping for the 18th month in succession.

But it is not just Sydney that has to be attuned to developments in China.

In April the Federal Reserve policy-setting committee said it was “closely monitoring… global economic and financial developments,” and China will loom large in those considerations.

Indeed given that a month earlier the Fed said “global economic and financial developments continue to pose risks” when it outlined its reasons for holding rates unchanged, it seems plausible that if the economic outlook for China becomes murkier, the greater will be the likelihood that the Fed stays its own hand.

That in turn would provide breathing space for countries such as Japan, whose exports fell for a sixth consecutive month in March, and South Korea, whose first quarter gross domestic product growth was held back in part by poor exports, to unveil looser policies that might make the yen and the won less attractive in comparison to the dollar.

Even Singapore might benefit.

While Singapore eased monetary policy last month by removing reference to the “modest and gradual” appreciation path of the Singapore dollar, the International Monetary Fund has urged the Singaporean authorities to remain “vigilant to signs of deflation” and adjust policy further if needed.

Without the added complication of the Fed hiking rates, the Monetary Authority of Singapore might have more space in which to act.

An absence of compelling US domestic economic data gives the Federal Reserve justification to pause, while the possibility that the economic outlook in China might become cloudier gives the Fed food for thought.

As that combination allows others room to ease their own monetary policies in pursuit of their own domestic economic agendas, by default it translates into a rising dollar.

“I have friends in China, all they do is watch the dollar, they love to see it go up,” said US Presidential hopeful Donald Trump recently, noting “it sounds better to have a strong dollar than in actuality it is.”

Be that as it may, even Mr. Trump may yet have to accept that global circumstances could lend themselves to renewed and broad demand for the dollar.