Why the tide is turning against the US dollar
If confidence in Trump’s political programme falters, and if Europe survives the ‘populist’ test in French and German elections, the strong dollar is at risk
You would be forgiven for feeling confused about the outlook for the major currencies over the coming months.
Uncertain economic cycles, mixed monetary messages and dodgy politics are leaving investors in a deep fog about future exchange rate trends. It will leave forex players at the mercy of casino betting in the months ahead. Heads you win, tails you lose.
Even the usually robust US dollar, the forex market’s friend in the last few years, is starting to lose its lustre as the market begins to reassess the outlook for US Federal Reserve tightening set against a less certain future for the American economy ramped up by new president Donald Trump. The vicissitudes of Trump’s first 100 days in office have hardly been a call to arms for US dollar bulls.
Meanwhile, the conventional wisdom of the stronger US dollar/Europe trade risks being turned on its head. Europe’s election cycle, considered by most forex pundits as the bête noir of the euro single currency, is suddenly looking a lot less menacing. Europe passed the election test in Holland last week and next month’s French presidential vote could well surprise on the upside for the euro.
Even dollar/Asia seems to be losing momentum. China’s worry about being branded a ‘currency manipulator’ seems to have prodded the authorities into drawing a discrete line in the sand to stop further slippage by the renminbi. And worries about the global outlook also seem to be sparking concerns among Japanese investors to return to home waters after the yen’s rout in the second-half of 2016.
It is all leaving currency expectations up in the air with little for traders and investors to get their teeth into. Expectations about growth cycles, inflation dynamics and relative interest rate plays may be pointing towards more US dollar dominance, but not by nearly enough to compensate for any ‘roll-of-the-dice’ political shockers. The markets will just have to play it by ear in the coming months and stay fleet of foot.
Next month’s French presidential vote, September’s German elections, the danger of Trump’s presidency getting badly bogged down and a deeper crisis developing over North Korea all have the propensity to whip up market volatility and leave currency players exposed.
Increased geopolitical uncertainties have a way of ending up in a stronger dollar, but not when the problem is home-grown and possibly centred on a politically hamstrung US presidency. This is maybe the reason why the dollar sold off after last week’s Fed policy meeting, even after raising rates by another quarter per cent, while leaving the door open for several more increases this year.
The Fed by rights should be doing more to ‘normalise’ interest rates at this stage of the US recovery cycle, with higher inflation waiting in the wings. But it is probably keeping its options open just in case Trump’s ‘America First’ strategy becomes derailed and the expected fiscal boost falls short. In which case, it will need to revert to Plan B and keep monetary policy accommodative for longer than planned.
No longer has the Fed got the first call on higher rates. The European Central Bank is already testing the water for higher interest rates in the not too distant future, while the Bank of England is also putting out feelers for higher UK rates down the line. The days of ridiculously cheap global money are over and the worm is turning to dearer money.
While the Fed has a much stronger relative interest rate and bond yield buffer and the US economy carries better comparative fundamentals, by way of stronger GDP and employment growth, it is not going to last indefinitely. The global business cycle is on the turn and the dollar’s relative currency advantage will eventually slide.
If confidence in Trump’s political programme begins to falter, the strong dollar is at risk. And if Europe survives the ‘populist’ test in French and German elections in the next six months, the tide will take another turn for the worse against the dollar.
The euro has withstood the ‘parity barrier’ versus the US dollar for a long time and could be ripe for a sharp ‘short squeeze’ back to last year’s highs around EURUSD 1.15.
Ironically, the tables could quickly turn the US into a ‘currency manipulator’ by default.