Conventional wisdom to start 2017 was that reflationary policies by the Trump administration would lift U.S. yields and this would boost the U.S. dollar. Instead the year-to-date has frustrated the conventional wisdom trades as U.S. bond yields have been contained and the dollar has struggled to build upward momentum. This has seen equities be the main beneficiary of the reflation trade as headwinds from a firmer dollar and higher interest rates have so far not materialized.
Trump and the Dollar
One reason why the forex market has had difficulty building trends is that there is a general feeling that President Trump favors a weaker dollar. This comes from comments where he has threatened China as being a currency manipulator as well as the head of Trump's National Trade Council signaling out Germany for taking advantage of an undervalued euro to build a large trade surplus. In addition, a strong dollar is inconsistent with a policy focused on reducing the U.S. trade deficit, boosting export and reviving manufacturing. So it is logical to assume that the T rump A dministration will pursue a weak dollar policy, which would pit it in a battle with fundamentals if the Fed raises interest rates sooner rather than later.
The Fed and the Dollar
How a weaker dollar can be achieved by words alone is another matter as the Fed looks to raise rates as other central banks maintain current monetary policies. In this regard, attention will be on the March FOMC meeting as the risk of a rate hike has been put back on the table. As John Bland, co-founder of Global-View.com, wrote on its Forex Forum,
Comments from Fed officials generally reinforced speculation about a March 15 rate hike, but we never know for certain who individual speakers are talking for, themselves or the central bank. My personal view is that the Fed would like to hike next month, but that they have no credible mechanism with which to communicate with the markets. In the past they have sent so many muddled messages that no one trusts them any more.
In any case, it is doubtful that the Trump A dministration would be able to coordinate a Plaza type accord to weaken the dollar given current fundamentals and contentious rhetoric towards its trading partners, so it would be a battle between actions (i.e. the Fed) vs. words (weak U.S. dollar policy). In addition, political uncertainties in the Euro zone (i.e. elections in the Netherlands, France and Germany) likely tie the hands of the ECB and further makes an coordinated effort to stem dollar strength unlikely.
This does not mean that words cannot have a short-term impact, as we have seen repeatedly this year, but that it would take more than jawboning to trigger a sustained run out of the dollar. We have yet to hear from the new U.S. Treasury Secretary, Steven Mnuchin, as this department is responsible for forex policy so keep an eye for when he speaks.
In any case, March will be a pivotal month as markets will get some clarity on Fed policy (March 15 FOMC decision) and on forex at the meeting of G20 finance ministers and central bank governors from 17 to 18 March 2017 in Baden-Baden, Germany. In the meantime, markets can only guess as the sense is the dollar should be moving higher but remains somewhat restrained .
Jay Meisler , founder
Global Traders Association