Dollar’s downtrend
Matein Khalid sees an interesting month for money markets
The US dollar index fell as low as 89 despite the sharp rise in the London Interbank Offered Rate. The primary reason for the dollar’s downtrend since early-2017 is the projected sharp deterioration in US trade and budget deficits.
It is ironic that the US dollar index fell as low as 89 despite the sharp rise in the London Interbank Offered Rate, a hawkish move on the 2019 dotplot by the Powell Fed at the March FOMC, the appointment of arch-neocon John Bolton on the National Security Council and subsequent rise in Iran/North Korea geopolitical risk and even selloffs in global equities.
This demonstrates that the primary reason for the US dollar’s downtrend since early-2017 is the projected sharp deterioration in US trade and budget deficits under President Trump and the rise in implied yields in the euro and yen in the cross-currency swap market. The White House’s tariffs on China precluded any safe-haven bid on the US dollar even while Facebook, Tesla and Amazon’s woes amplified the US stock market declines on Wall Street. The safe haven beneficiary was the Japanese yen, not the dollar.
A major theme of 2018 was the rise in the 10-year US Treasury note yield from 2.40 to as high as 2.94 per cent. However, the decline in global equities, a consensus that first-quarter GDP growth will disappoint and foreign central bank buying of Uncle Sam debt has meant the 10-year US Treasury note has fallen to 2.74 per cent now. This fall in US bond yields will not last as tax reform alone ensures that economic growth will continue to accelerate in 2018’s second, third and fourth quarters even while a tight labour market almost guarantees a rise in wage inflation. Yet the real lesson of 2017 was that higher US money market rates or bond yields are not enough to ignite a turnaround in the US dollar index. Planet Forex, after all, is about relative, not absolute, money rate trends.
Even though the US Dollar Index rose 1.4 per cent as fears of a trade war (and hot war, given North Korean dictator Kim Jong Un’s train trip to Beijing) receded amid shortcovering, it seems the longer-term destiny of the greenback is bearish in April and May, though not dramatically so.
German economic data reinforces my view that the Teutonic Fatherland’s growth momentum is intact despite the rise in the euro from its pre-Macron lows. The German unemployment rate has now fallen to 5.3 per cent, a low for this business cycle. German consumer price inflation has risen to 1.7 per cent at the Federal level. So it was no surprise that ECB governor Knot hinted about a phase out of ECB asset purchases by September. There was consistent buying in the Euro anytime the EU’s single currency dipped below 1.23. I would expect supports in the 1.23 level to encourage a rise in the euro to 1.25 in April.
UK economic data was softer than expected. London home prices now exhibit all the telltale signs of a cyclical property market peak, though Liverpool, Manchester and Edinburgh house prices have risen by 6-8 per cent. The rise in UK food and petrol prices after sterling’s post-Brexit fall in 2016 and 2017 means Governor Carney will be compelled to hike the Bank of England’s base rate in May and November 2018. GDP growth in Britain is still mediocre, mainly due to weak consumer spending on the High Street amid weak real wages. Yet
it seems the longerterm destiny of the greenback is bearish in april and May, though not dramatically so
sterling’s decline to 1.40 is really profit-taking after its surge since the early-1.30s on euphoria over the Brexit transition deal. As long as 1.40 holds, I see no reason why cable will not test 1.44 in April.
The yen fell below 106 against the US dollar as the financial markets lowered their risk assessment for a trade war and North Korea’s offer for a summit with Japan had a seismic impact on the reversal of geopolitical safe haven flows. Risk reversals in the Tokyo foreign exchange option markets suggest lower demand for protection against yen strength. This means an optimal range of 106-109 for the yen in April is not unrealistic as long as the US Treasury-JGB 10year note spread widens beyond 2.80 per cent.
The Canadian dollar has underperformed in 2018 against the greenback and the G10 currencies. The loonie’s weakness is due to Nafta fears, the risk of delay in the Bank of Canada rate hikes and soft domestic data. I view the loonie as a buy at 1.30 for a 1.25 target by end April as the tone of the Nafta talks stabilise while the Ottawa central bank hikes rates again in July and West Texas crude trades at $65, improving Canada’s terms of trade.