USD remains upbeat – Natixis

Research Team at Natixis notes that 2017 has kicked off with a significant decline of the US dollar as most currencies have benefited from the greenback’s bout of weakness, notably commodity currencies that have drawn strength from the continuing upturn in crude oil prices.

Key Quotes

“This bout of weakness was brought about by the FOMC minutes, which revealed the Federal Reserve’s reservations as regards Donald Trump’s economic programme when it comes to spending and deregulation. The minutes also alluded to the risks of a strong dollar for both economic growth and inflation. For these reasons, the central bank explained that the monetary tightening had to be a gradual process.”

“Our view is that these concerns are a little over the top in that inflation should rise well above 2% simply because of base effects for energy prices. Similarly, US growth seems more solid and is absorbing relatively better the recent appreciation of the US dollar, as underlined by the improvement in the manufacturing ISM to 54.7 in December, beating the 53.8 consensus. Bear in mind that the economy has reached full employment. In short, the situation is not as it was at the start of 2015, when the Federal Reserve fretted on several occasions about the effects of a strong dollar, as during this period growth remained fragile.”

“Furthermore, the US dollar has been affected by concerns protectionism is rearing its head, a risk that had largely been ignored until now, as the market was focusing rather more on the fiscal policy of the next US administration. These concerns were revived when Donald Trump pressured Ford into dropping plans for a new plant in Mexico and invest instead in the US. He has also threatened GM and a number of foreign firms, including Toyota, with higher border taxes. All these announcements do not bode well.”

“Protectionist measures would clearly be negative for the US dollar. This risk was largely overlooked until now, as Donald Trump seemed to be focusing on fiscal measures favourable to the economy and the market. Clearly, protectionist measures in the US will trigger reprisals by other countries, China in particular, which will further penalise what is already weak global trade. All in all, this would not be good for the US economy, with the risk that stagflation will take hold, i.e. weak growth coupled with stronger inflation, as suggested by FOMC member John Williams.”

“Before his inauguration on 20 January, Donald Trump has scheduled a press conference on 11 January, when more might be revealed about his programme for the short term. Attention will also focus on the many speeches by FOMC members (notably by Fed Chair Janet Yellen on 13 January), which will be watched closely by the market to fine-tune the timing of the next interest rate hike by the Federal Reserve, bearing in mind the December Employment Situation Report was good, with notably a further increase in average hourly earnings (up 2.9% year-on-year), which can be expected to stoke inflation concerns. As regards macro publications, watch out for retail sales. In this context, the US dollar should firm.”