Originally published by IG Markets
Donald Trump has taken office with much fanfare and it is fair to say the next 97 days will occupy traders and investors minds alike. There is a view from certain circles that over the coming 12 months the US dollar, which along with the US 10-year treasury have become the must-watch markets for 2017, will only go higher.
The simplistic argument behind this view is that we are either going to see higher inflation expectations pushing the Federal Reserve to hike three times this year. Obviously, this would be down to a successful roll out of tax cuts, infrastructure plans, and a tax repatriation holiday and of course, less regulation through a repeal or amendment of Dodd-Frank.
The other view for a higher US dollar is that we are going to see protectionist measures, which in turn cause a wave of capital to be repatriated by US companies.
Morgan Stanley (NYSE:MS) coined the phrase ‘a good US dollar and a bad US dollar’ and depending on the path the US dollar takes will determine the label. This is certainly an interesting view, and if you believe their theory could shape a longer-term directional bias for the US dollar, which of course FX traders will need to trade in and out of. Certainly, technically the US dollar basket is back testing the neckline, so a rejection of this level from here would certainly provide traders with a far better entry point if the US dollar genuinely can only go higher!
As Trump starts his first 100 days the headlines are rolling in and it’s almost hard to keep up. The narrative around tax has been widely discussed, while we are now hearing of some 50 infrastructure projects, totaling $137.5 billion. We have seen President Trump sign in an executive order in support of the Keystone XL pipeline and Dakota Access pipelines, subject to ‘terms and conditions’, where these projects are expected to create tens of thousands of jobs. It has been talked about that Trump is meeting US automakers with the idea to urge them to boost productivity.
This is exactly what traders need to hear, because the 4% decline in the US dollar from 3 January to 23 January was really premised on traders reducing a rather large USD long position, amid a lack of patience in the understanding of Trump’s fiscal policy initiatives. What we are seeing first hand is a president who wants change in America and wants it quickly. The market will warm to this urgency and let’s not forget that Trump’s economic team are more in tune with financial markets than any other administration, given the level of ex-Wall Street executives.
So, as we get further clarity on policy I think it’s important to understand what to look out for to drive the US dollar into this idea of a ‘good’ or ‘bad’ US dollar camp. Clearly, the major smoking gun and the poster child of all things protectionism comes with the Trump’s administration relationship with China. 45% import tariffs are not going to be taken well by markets and while the idea is to boost US corporate activity domestically, the impact of a sharp tightening of financials conditions could seriously damage the US economy. Tread carefully when the feedback loop of tariffs on China could ultimately be a weaker US economy.
It is also worth keeping in mind that we get the next US Treasury FX report in April and there could be some tensions ahead of this meeting. If Trump can convince Steven Munchin and US Treasury department to label China a currency manipulator this would cause angst in the market. USD/JPY would be sold initially as traders seek the safety of the yen, but could reverse on the idea of capital repatriation into the US dollar.
On the reflation side, we need to see signs that businesses are responding and that there are wild, insatiable animal spirits which can drive increased productivity and investment. This is how we get to 4% annual growth and potentially 25 million jobs over the coming decade, even though the figures are rather optimistic. This means watching key economic data points that highlight domestic demand. These include the NFIB small business optimism index, capital goods orders and the new orders sub-component of the monthly services and manufacturing ISM. Expect these data points to get much greater attention from here.