Despite a series of significant uptrends and downtrends since March, the US dollar has largely been bound within a trading range of between 115 and 108 against the Japanese yen for much of the year.
Growing doubts about the Fed’s ambitious projections of one more rate increases in 2017 and three hikes in 2018 have weighed on the yield of 10-year Treasury notes, which peaked at 2.629% in March and currently stand around 2.185%. However, another factor in putting an end to the dollar’s post-election rally has been the never-ending saga of political upheaval in the White House and in turn, fading hopes of a fiscal stimulus anytime soon. Ongoing troubles in the White House have been capping any advances the dollar has been able to muster from positive economic data.
The dollar’s decline has been even steeper against other currencies, particularly against the euro, which is up 12% in the year-to-date. Even the Brexit-battered pound has gained versus the dollar so far this year. Against the safe-haven yen, the greenback is currently down by almost 7% since the start of 2017 as it hovers near the bottom of its range that’s been in place since mid-January. It’s worth noting though that when the dollar is trading near the top of its present range, those losses are limited to just under 2%.
The troubles in the Trump administration started on January 30 soon after the President took office and he fired the acting Attorney General, Sally Yates, after she refused to defend Trump’s ban on immigrants from several Muslim-majority countries. They escalated on February 13 when Michael Flynn, the national security advisor was forced to resign over revelations of potentially illegal contacts with the Russian ambassador to the US. The next major departure came on May 9 when Trump fired the FBI director, James Comey. This was followed by the exit of Trump’s first communication director on May 30. But the scale of the turmoil in the West Wing only became apparent in July when Tump’s second communications director, Anthony Scaramucci, his press secretary, Sean Spicer, and chief of staff, Reince Priebus, all departed within days of each other.
There was some positive news for the markets in August when the President’s chief strategist, Stephen Bannon, a known economic nationalist, was fired by Trump on the advice of his new chief of staff, John Kelly. Bannon was widely credited for driving much of Trump’s anti-immigration and anti-trade policies and his departure gave some hope to market participants that Trump would tone down his rhetoric on trade and immigration. It’s also a sign that the newly appointed chief of staff and retired general John Kelly is able to get a tighter grip on the White House, bringing discipline to the disorder.
While the series of resignations and sackings in July exasperated the dollar’s decline from its July peak of 114.49 yen, the downtrend was triggered by an apparent shift in the Fed’s stance to a less hawkish one. Federal Reserve Chair Janet Yellen voiced some concern about the softening in US inflation at her semi-annual testimony before Congress on July 12. Interestingly, the March downtrend was also sparked by the Fed, following the not-as-hawkish-as-expected FOMC projections from the March policy meeting, while the May downtrend came about from disappointing economic indicators.
This suggests Fed policy remains the main driver for the greenback despite the growing volatility and uncertainty being generated by White House developments. The next big move by the Fed is expected to come at the September policy meeting where they will likely initiate their well-telegraphed balance sheet reduction plan. Concerns about a possible government shutdown are unlikely to derail the Fed’s plans unless it was to lead to a market panic.
President Trump this week threatened to shut down the government if Congress did not provide funding for his election pledge to build a wall across the Mexican border, adding to the unease in the markets. However, the dollar remains off its four-month low of 108.60 touched last week and could be on the verge of a new uptrend if it bounces off its support level of the bottom of the range, as it has done after the previous downtrends reached this area.
As sentiment for the dollar turns increasingly negative, with a bearish crossover of the 50- and 200-day moving averages in July underlining this view, it might not take much to trigger an upside correction. However, the odds for a breach of the range bottom is as likely, if not greater, given the downside risks. As dollar/yen wavers near this support level, direction could come either way from the Fed and Washington.
While Trump’s record in the White House leaves much to be desired, progress on the tax front is not inconceivable as the reforms have broad-based support within the Republican party. Traders are unlikely to push the dollar substantially higher however, unless there was evidence that the tax reform plans were moving significantly forward as there’s always going to be the risk of the President creating unnecessary distraction and antagonising his own party. Trump’s response to the recent events in Charlottesville, Virginia may have lost him some key support from not just the Republicans but also from the business community.
Meanwhile, as the Fed appears to be taking a more cautious approach to inflation, markets may be underestimating the likelihood of another rate hike this year. Although various measures of inflation have weakened over the past few months, the labour market continues to tighten and consumer spending has rebounded from a soft patch earlier in the year. More importantly for the Fed, market volatility is at a record low, the dollar has depreciated substantially this year and financial conditions remain loose. Therefore, it could only require a minor reassuring uptick in price pressures to prompt Fed policymakers to resume their rate hiking cycle.
Alternatively, signs of further delays in Trump’s economic agenda would only increase the bearish bets already placed against the dollar. A deepening turmoil in the White House as well as a possible escalation of tensions with North Korea could overshadow strong economic data. However, an increasing number of analysts are taking the view that low inflation is here to say and are not forecasting interest rates to peak much higher from their current levels. The next FOMC projections due on September 20 will be especially interesting to watch for any change in committee members outlook on inflation, as well as the updated dot plot chart.
