US Political Risks Loom
Looking back at price action over the last few weeks USD has weakened against those currencies sensitive to sentiment as long-term US rates have dropped slightly and most equity and commodity prices have increased. The movement in popular long USD positions held against JPY and EUR were much more limited. Despite USD weakness last week, USDJPY is still around 13% higher than at the end of Q3 while EURUSD is around 6% lower.
While the USD bull trend remains intact, upcoming US political risk could fuel further USD consolidation in the near term. This week marks the beginning of confirmation hearings for President-elect Donald Trump’s administration officials. Although the appointees are likely to be confirmed, the additional Democratic scrutiny could inflict some delays and perhaps cause some to debate the speed of policy implementation.
Policy Statements to Be Watched
Furthermore, if the first formal policy statements from the Commerce Secretary, and Head of US Trade Representative Office strike a protectionist tone regarding trade, this is likely to worry markets. Trump’s press conference this week, as well as his inauguration speech due on 21st January, will also likely shed further light on the likely White House policy agenda.
The clear repricing of US markets following Trump’s victory reflects the view that investors believe the President’s elects promises of increased fiscal expenditure and a reflated US economy. Inflation expectations have picked up significantly whilst the Fed’s own projections for the 2017 rate path have also moved higher as of their last FOMC meeting. Indeed, just yesterday Fed’s Rosengren as calling for a faster pace of rate hikes over 2017.
Risks to Reflation
The risk to the Trump’s promises of reflation is that he could pursue a policy path which would ultimately damage growth and global risk appetite. Areas of potential concern include a potential trade war with China, naming China as a currency manipulator, a trade war with Mexico, implementing a tougher immigration policy on Mexico and or building a wall along the border.
For now, the surge in USD seems aligned to the market focusing only on the potential positives of Trump’s policies and ignoring the possible negatives. Should Trump act on any of the more controversial policy areas USD would likely weaken against safe havens such as JPY and CHF and also concede gains against EUR also.
Trump To Moderate Views
The baseline scenario, however, is that Trump avoids the more extreme and potentially damaging policy areas. However, it is unclear yet whether the “good” policy areas will quickly generate the sort of US growth that markets appear to be pricing in. For example, a surge in interest rates could create a negative feedback loop for the economy through higher funding costs whilst a stronger USD could prove to be a headwind for growth and inflation.
The USD rally also faces downside risks from the potential slippage in delivering reflation-friendly policies. Although the Republican party has control of Congress, this doesn’t guarantee support for all of Trump’s proposals. Any delays or amendments to proposals might see the market react with disappointment leading to a USD unwind.
For now, the market seems content to believe in “Trump-flation, ” and despite the current pullback, dip buyers are likely to emerge soon to take USD back higher once again.
Technical Picture
Having broken above the prior 2015 high around 100.50s, the Dollar Index then proceeded to break out above the 61.8% retracement of the 2001 highs. Price has since pulled back and is now testing the broken Fib level from above which, for the time-being, is providing support. Below here, look for a retest of the broken 2015 highs as the next key support level.
On the data front, the next key releases for the US will be Retail Sales and the University of Michigan Confidence both released on Friday. Ahead of those releases we also have a slew of Fed members speaking. Earlier in the week Fed’s Rosengren noted that he saw the need for a more “gradual, but faster pace” of rate hikes over 2017. Traders will be keen to see if the other Fed speakers reiterate this viewpoint.