How to read the outlook for the US dollar
‘The euro and the Japanese yen are bound to be major beneficiaries from the dollar’s plight’
The dollar has had a challenging year to date and the odds are it will get worse before the outlook improves. A beleaguered US President Donald Trump, a dithering Federal Reserve and a general loss of market confidence in the currency all add up to a pile of problems for the dollar. The dilemma for investors is the alternatives may seem better bets for now but most major G-10 currencies have their gremlins. The dollar is not alone.
The dollar has had a rough ride so far in 2017, broadly losing around 10 per cent of its value against a range of major currencies, with the odds slanted to the downtrend continuing for quite some time. According to recent market data, speculative positions are just starting to build into a more negative outlook ahead. Any number of factors could tip the scales towards a bigger rush to the exits.
The US runs two big deficits in the shape of the nation’s large trade gap and the government’s budget deficit. In order to keep the dollar on a reasonably firm footing, the US needs to attract strong capital inflows. The US manages this by virtue of the world’s insatiable appetite for US financial services and demand for the dollar as the world’s No 1 reserve currency. But confidence here is the key.
And right now, market confidence in the US is in dwindling supply. Political ructions in the White House and uncertainty in the Fed about the outlook for US growth and inflation and their likely monetary policy implications are muddying the waters for investors. All of a sudden dollar perceptions are tumbling back down the rabbit hole again.
There should be no doubt about Trump’s presidency being in deep trouble. Late last year the markets were full of praise that the new presidency could bring sweeping change and reforms to the US economy, paving the way for new stimulus. The Trump “bump” has never materialised and the administration is now bogged down infighting with lost policy initiatives on many fronts.
Trump’s presidency looks like a survival course strewn with impassable obstacles. Trump seems increasingly isolated after the departure of so many key allies and advisers and it is hard to think how he can recover. With main muse and chief strategist Steve Bannon now gone, the market should resist any temptation to think redemption is close. A long and bumpy political road ahead seems likely.
Markets hate uncertainty so it is no surprise the Fed’s “will-o-the-wisp” vacillation over interest rates is going down like a lead balloon with dollar currency perceptions. Of course, it may be the Fed’s sneaky plan as the dollar’s 10 per cent fall in the last eight months is the monetary equivalent of 2.5 per cent lopped off short term interest rates. This is a big bonus to US exporters without the Fed lifting a finger.
In the short term, the odds are the dollar has more to go on the downside, possibly with another 5 -10 per cent on the cards if the going gets tough. Much depends on how well the president fares and whether the Fed takes a deep breath and gambles with a continuation of tightening. In the meantime, the euro and the Japanese yen are bound to be major beneficiaries from the dollar’s plight.
With confidence in the euro area recovering and strong capital inflows chasing European stock markets higher and with the yen buoyed by safe haven inflows to Japan, the dollar’s secular downtrend will continue. However the watchword must be caution on the market ultimately overshooting.
Currency markets remain fickle friends and they have short memories too. It was not so long ago that the euro was being written off as a car-crash currency, while the yen has been riddled with deflation flaws for years. Meanwhile, the UK pound has been battling Brexit demons for months.
And with so much uncertainty surrounding the global economic outlook, commodity based currencies like the Canadian, Australian and New Zealand dollars remain at risk from a downturn in growth perceptions.
There are good reasons why the dollar has a reputation as a safe haven currency in times of peril. In the past it has stood rattled investors through thick and thin in times of global stress and instability. It has earned its spurs as a reserve currency out of hard experience. Investors should avoid writing the dollar off too soon.
David Brown is chief executive of New View Economics