WORLD MONEY

For currency traders across markets, selling the US dollar has been one of the popular trades in the market. Battered by political drama in Washington and shifting bets on the Fed’s monetary policy, the American currency has declined the most this year since 2003.

The reasons are well known. On the political front, Donald Trump’s failure to deliver on his policy agenda (starting with the repeal of Obamacare) stymied hopes of a rapid economic revival in the US driven by lower taxes and massive government spend. Then there was the US central bank, the Federal Reserve, that lost its edge and was no longer the only major central bank working towards monetary tightening. If it had been the sole monetary authority to do so, the dollar would have got a pop. The Bank of Canada, the European Central Bank and the Bank of England also joined the race, making the US dollar less attractive on the basis of yield differences.

However, as it turns out, things have come a full circle and there is every chance that the US dollar may be bottoming out for now. The sharp fall in the rupee on Thursday and Friday has to be viewed against this backdrop.

Why so? For one thing, the hope that Trump’s tax package might see the light of day has resurfaced. Ten months into his term, Trump seems to be learning to deal and indeed collaborate with the Opposition. The recently concluded debt ceiling agreement, where he overruled his own treasury secretary and decided to cut a deal with the Democrats (to raise the federal borrowing limit), has boosted market sentiment. There is now talk of delivering on more election promises, especially tax cuts with some help from across the proverbial aisle.

Besides, contrary to expectations, the Federal Reserve doesn’t seem to be worried that inflation continues to be softer than its target. If the message from the high-powered Federal Open Market Committee (FOMC) that met on Wednesday and Thursday last week is any indication, the central bank is looking to hike rates and reduce its balance sheet (tightening money) despite the catastrophic damage from the hurricanes in Texas and Florida. This somewhat unexpected hawkishness from the Fed is providing another support to the dollar.

Should we thus assume that the beaten-up currency is staging a major comeback? Is the “Trump trade” back? To answer these questions, there are two important aspects to consider.

One, there could be many a slip between the cup and the lip when it comes to tax reforms. Republicans plan to use a process known as reconciliation to pass tax cuts, which would require approval by 50 senators. With only 52 seats (and many a dissenter within its fold), the Republican margin remains wafer-thin and whether or not Democrats actually play ball remains to be seen.

However, Trump’s sudden overtures to Democrat house leaders Charles Schumer of the Senate and Nancy Pelosi of the lower house on issues such as the Deferred Action for Childhood Arrivals programme and the deferral of the federal debt ceiling restriction seem to suggest a newfound love between Trump and the Democrats that could translate into support for critical legislation.

However, there is a risk that he could alienate his own party in the process. With mid-term elections on the horizon, Trump’s friendship with the Democrats could be a political liability, especially for the hard right within his party. Thus, it is important that that the White Hose sews up a tax cut deal before a sharp partisan divide resurfaces.

The Fed’s policy stance remains uncertain despite the recent communiqué. At this stage it believes that inflation will eventually rise in the US and it is important to tighten financial conditions and look at risks related to asset price bubbles. However, if the economic data for the next couple of months look particularly soft and inflation begins to surprise on the downside it might not want to get too aggressive. Not to forget, there are a lot of seats to be filled within the FOMC and its composition and outlook could change significantly, especially given that Chair Janet Yellen’s term will end in February 2018.

So is this the beginning of a dollar rally? Nah, it’s really too early to tell. But can markets afford to ignore this nascent strength? Clearly not.