USD: still at the mercy of President Trump

6 February 2017  •  Source: Nordine Naam, Natixis

US President, Donald Trump, has continued to wade in with off-the-cuff comments. One of Trump’s advisers, Peter Navarro, head of the newly-formed National Trade Council, said that the euro was both grossly undervalued and being exploited by Germany in order to gain an advantage over the US and its own EU partners.

This followed an earlier salvo by Trump bemoaning the US dollar’s strength and the announcement of numerous protectionist measures, including the withdrawal from the Trans-Pacific Partnership (TPP) and the renegotiation of the North American Free Trade Agreement (NAFTA). Trump seemingly wants to end these regional agreements in favour of bilateral agreements that would be more advantageous to the US.

All these announcements have undermined the US dollar since the start of the year causing the US dollar index (DXY) to pull below 100. Despite the very sharp improvement in the Manufacturing Institute for Supply Management (ISM) and ARP Employment Report in January Q1 2017, the US dollar has failed to surge. Also, the University of Michigan consumer confidence index stands at a 13-year high. Following the last Federal Open Market Committee (FOMC) meeting, the wording of the statement was unchanged even though the Federal Reserve is more optimistic about growth. As yet, the central bank is waiting for more details regarding the substance of Donald Trump’s programme before further tightening monetary policy.

However, we do expect a further tightening of the Federal Reserve’s monetary policy this year. The bull run on the equity markets – and the tightening of credit spreads – mean that monetary and financial conditions have improved. This suggests that the US economy might be able to absorb an increase in the Fed Funds rate in coming months. At the same time, the central bank, awaiting further information on the new administration’s economic programme, has already ruled out an interest rate hike at the March meeting.

Given the lack of visibility on Trump’s economic policy, and the negative news flow from the Trump administration aimed at curbing the strength of the US dollar, it is difficult to say how low the US dollar could correct. The risk of trade wars with China, Mexico, even the European Union can no longer be ruled out. And that would be clearly negative for the US dollar.

In the very short term, there are two factors that could bolster the US dollar. Firstly, a announcement detailing Donald Trump’s economic programme. Secondly, a hike in the Fed Funds rate in response to a surge in inflationary pressures. This would force a rapid response by the Federal Reserve lest it falls behind the curve. It is, however, difficult to put a timeframe on these two factors.

In this environment, the US dollar will extend its poor run, remaining at Trump’s mercy before the Federal Reserve gets back behind the helm. However, the market will continue to track macroeconomic publications, in particular inflation and hourly earnings, also any announcements by president Trump.

EUR/USD: seems toppish

Because of the US dollar’s bout of weakness, the EUR/USD extended its rise, breaking above 1.08. However, the euro appreciated only against the US dollar and sterling, despite the publication of some positive macroeconomic indicators likely to stoke market doubts as to whether the European Central Bank (ECB)’s asset purchase programme will stay the course until the end of the year. In this respect, the Eonia forwards curve has steepened anew since the start of the year. The Purchasing Managers Index (PMI) surveys came in above expectations, as did the January inflation flash estimate (1.8% compared with an expected 1.5%). At the same time, however, core inflation (i.e. ex-energy and food) was unchanged at 0.9%, which remains very low.

Despite the euro’s rebound since the start of the year, we remain negative on the EUR/USD. The divergence in the monetary policies of the Federal Reserve and ECB will be favourable to a decline of the EUR/USD in coming months. It will not be long before European political risks weigh on the EUR/USD with the upcoming Dutch general elections on 15 March. Indeed, the risk attached to this event has not been priced in sufficiently, given the PVV (Eurosceptic party headed by Geert Wilders) is leading in the opinion polls.

Although the PVV won’t be able to govern without forming a coalition (credited with 35 seats, when 76 are needed for an absolute majority), a victory is unlikely to go down well with the market – especially when the French presidential election follows shortly and its outcome is uncertain.

The bond market has started to price in the French risk, with the OAT-Bund spread widening from 30bp before Trump’s victory to 62bp currently. In this environment, the EUR/USD can be expected to resume its descent towards parity in Q2. Finally, the rebound of the EUR/USD has been fuelled by the squaring of short euro positions, which are no longer very significant. This suggests that the EUR/USD has some downside once the market begins shorting the euro once again. We see 1.08 as already being an attractive level for selling the EUR/USD.

EUR/GBP: heading towards 0.90

From a high of 1.27, the GBP/USD fell back to 1.255 at the end of last week after the meeting of the Bank of England’s Monetary Policy Committee (MPC). Yet the central bank revised its growth forecasts from 1.4% to 2% for 2017, while several members expressed concern at the stronger inflation, which could reach 2.7%, some fearing a peak at 4.0%. Mark Carney, Governor of the Bank of England, sought to minimise the revised forecasts, pointing out that the British economy was still characterised by significant slack in production capacity and that Brexit would have negative effects on growth sooner or later. Furthermore, the government’s Brexit strategy whitepaper did not shed any light on the upcoming negotiations. The intention is to negotiate a deal in the two years following the triggering of Article 50. In reality, negotiations with the European Union could drag on far longer. We therefore see the GBP/USD falling back towards 1.18 in Q2. The EUR/GBP could make a brief foray towards 0.90, but the pair should go on to stabilise around 0.87.

USD/JPY: heading towards 115

The Japanese yen was extremely volatile last week, the USD/JPY falling just short of 112. The yen strengthened in reaction to the bear run on the equity markets and to the downturn in US long interest rates. Also, the market doubted the Bank of Japan’s (BoJ) resolve to intervene in the bond market to limit the upturn in the Japanese 10-year rate, which tested 0.15%, when it is supposed to remain pegged at zero percent. The central bank was forced into an unannounced intervention to reassure the market. Despite this, the yen’s fate will be determined by the US dollar and, more generally, the direction taken by US long interest rates. A recovery of the USD/JPY towards 115 remains likely over the next few trading sessions.

Sell AUD/USD on any recovery to 0.77

The Australian dollar recorded one of the strongest increases last week. The AUD/USD neared 0.77, a level tested unsuccessfully on several occasions in 2016, so we remain cautious on the Australian currency. It benefited from the rise in iron ore prices to $82/t and from the improvement in Chinese growth. As price levels are not sustainable, this will weigh on the Australian dollar. Despite macro indicators such as the NAB survey and trade surplus showing an improvement, inflation remained weak at 1.5% in Q4 2016. For this reason, the Reserve Bank of Australia (RBA) is likely to be very cautious when it meets this week. We recommend selling the AUD/USD on any recovery to 0.77.

Play an extension of the AUD/NZD’s rebound to 1.065

The New Zealand dollar was very volatile in last week, penalised to some extent by the upturn in the unemployment rate to 5.2% in Q4 2016, when the consensus had been for 4.8%. Under these conditions, the Reserve Bank of New Zealand (RBNZ), which meets on Wednesday, is likely to adopt a dovish bias, especially since the New Zealand dollar remains one of the most overvalued currencies. Therefore, the AUD/NZD could rebound to 1.065.

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