Who will win the Battle of the Dollar?
Who will win the Battle of the Dollar? Feb 5th
The answer is the cynic or the patient pragmatist.
Many (more than most believe) have been quick to jump on 2017’s USD weakness as the beginning of a new USD downtrend. Although we believe this will be the ultimate verdict of 2017, we also believe it is too early. Why? Because it is not supported by interest rates. The Dollar has weakened while interest rate differentials have remained relatively stable. Miracles may exist but not in financial markets.
The Forex market is, or rather should be, driven by interest rate differentials. It is why after all we reversed our EURUSD long at 1.0815 as the differential had already turned lower.
And yet research shows the correlation between interest rate differentials and currencies is not as strong as people think. In an immediate time frame (ie rate announcement) and the long term we all know the link is there. So what about in between? It is there but disguised by a varying time lag that seems to defy quantitative analysis. It is skewed because interest rate consideration are not always to the fore. In other words, money is flowing in and out of currencies for some other reason.
It is why, at Matrix, we employ a FITS (Fundamental, Intermarket, Technical and Sentiment) scoring system to highlight what is really driving a market. If our F rating is constantly a 4 or 5 out of 5 for the EURUSD, the correlation between the 3 month EURUSD differential and the currency pair presumably should be high. However the Dollar has weakened in part due to recent political rhetoric from the new administration as President Trump seeks to regain a competitive advantage for the US. With such an unprecedented start to a new Presidency perhaps we should introduce a FIRST rating system instead to include an R for Rhetoric because it clearly has had an effect.
But that impact on the flow out of the Dollar has been on ‘Sentiment and not supported yet by either a sustained US inflation undershoot or higher economic growth, inflation and interest rates elsewhere. But sentiment can be quickly or slowly broken. It took six months the last time interest rates and the USD diverged over very bearish Chinese RMB and bullish USD sentiment.
This time we expect it to be quicker then not, quicker then not. Simply because the market will remain in a vacillating limbo between ‘words’ and ‘action’. Previously the fast stream of strong expansionist rhetoric from Donald Trump served to strengthen the USD, stocks and interest rates – unsustainable in the longer term if unfunded by tax. Donald Trump or his advisers know that a revival in US manufacturing cannot be maintained (without exports) with a continually rising Dollar (not even mentioning NAFTA and its possible impact on the US auto sector).
So talking the USD down serves a purpose but can only be sustained with action. And the only way to weaken the USD would be concerted intervention, a revival of QE or a collapse in the US Bond market due to a runaway budget deficit. None of these are likely..yet. What is more likely is continued improvement in the US economy with the consequent fear of rising inflation and interest rates particularly if Donald Trump enacts his expansionist rhetoric. That sentiment will support the Dollar until it is broken again by political currency rhetoric.
Earlier this week Business Insider published a condensed version of our FOMC Special. This highlighted a potential conflict later in the year between an inflationary Presidency and a Federal Reserve that seeks to counter that inflation. Until action speaks louder than words the war will be phoney as indeed is the Dollar downtrend.
So what will benefit most out of US growth and a rhetoric checked Dollar? Stocks not bonds.
As Zero Hedge pointed, referencing our stock market view. The extreme can get more extreme:
In the words of Take That:
Just have a little patience
I’ll try to be strong, believe me
I’m trying to move on
It’s complicated but understand me
‘Cause I Need time.
The market continues to react not just to the new world of Donald Trump and his controversial policies but the less flamboyant central banks of the world. Overall we saw a gentle net rise is SPX, but a fade in USD preventing the effect moving into non-US indices. FTSE and GBP continued to do their own thing as the machinations of Brexit continue.
The previous week ended with the US GDP Miss and set the context for a series of Central Bank meetings that prevented a USD recovery and the GDP (average) Fractal from continuing for the whole week.
The week started with almost an exact repeat of the previous Monday with bullish sentiment breaking over the weekend with a Trump immigration ban inspired sell off in stocks. Interestingly traditional correlations came back in line with VIX Gold and JPY rallying the latter enervated by BoJ concerns for Tuesday. DAX and NKY were down, pushed by the German inflation miss at 1300 and SPX gapped down and followed suit despite the US Consumption beat at 1330. It made a slight recovery in the late US session. Gold was up and oil was down, both trends which lasted until Thursday, but currencies were mixed. EUR and GBP were down, although the latter recovered, however CAD and JPY were up and AUD was flat. Bond yields were volatile but flat, as they were all week until Friday.
The BoJ rate decision was an hour late at 0300 and a non-event (a 45 pip drop recovered in 30 minutes). Stocks sold off again after the BoJ, swiftly followed by the USD following the BoJ Fractal. This was fueled by month-end hedge fund re-balancing which stopped exactly at their 1600 deadline. After that SPX DAX and NKY and bonds recovered a little. JPY EUR and CAD were sharply up, the latter two helped by the Eurozone 1000 triple beat of CPI, GDP and unemployment, and Canada’s 1330 GDP beat. FTSE and GBP did their own thing (in reverse of course) as they did all last week, and the rest of this week.
Wednesday was a relatively non-eventful day in anticipation of a non-eventful FOMC. Only oil, the market least affected by interest rates moved out of it’s range even after what was the most uninteresting Fed rate set meeting for months. Indices (FTSE in USD of course) were fairly flat, as was gold and USD pairs. This was despite a strong 81k (46%) beat on ADP Payrolls, in a week when ADP and NFP estimates were only 10k apart, and US Manufacturing PMI beat at 1500, although this did recover a fast opening drop in SPX.
Thursday set up the rest of the week with both AUD and GBP breaking to new highs in front of the BoE meeting, which was a 9-0 rate hold at 0.25%. Carney’s talk of interest rates going either way with higher growth but lower inflation sent the GBP crashing back down.
SPX NKY and DAX were flat again, and USD was muted. Only AUD rose, no doubt mapping gold. GBP fell more as a function of existing positions and, in the end, was only giving up Wednesday’s gains. Oil received an early boost with news from Trump of deregulation of the transparency rule on payments to foreign governments but gave this up later. Bonds were quite volatile and yields rose again.
Non inflationary growth had seemed a thing of the past until Friday’s NFP beat at 1330 confirmed the special UK-US relationship with the US posting higher payrolls but less than expected wages growth. Unusually for 2017, the USD sold off to their lows while stocks rallied back to their highs. DAX in euros hadn’t woken up since Wednesday choosing to ignore the move while the ‘real’ market DAX expressed in USD rallied in its place.
The Trump announcement boosted the equities effect further with the retail lending regulations being eased, with 4.5% rises in Goldman Sachs (GS) and Visa (V) for example. Goldmans at 7.91%, is the largest component of the DJIA by weight. The USD slight fade gave a boost across the board to currencies, but the true effect was yields gave up all Thursday’s gains.
The weekend sees Angela Merkel address her party at 1100 Saturday, and on Sunday, Bill O’Reilly from Fox interviews Trump in the Superbowl LI pre-game show around 2300, just as the futures markets open. Wild statements in tiny volumes can cause wild swings.
A much quieter week than last week will allow our NFP and FOMC fractals to unwind. There are very few significant European or US scheduled economic releases all week.
The week opens with Australian inflation at 0000 and Retail sales half an hour later. During the European session, the UK parliament starts three days of detailed Brexit examination, and ECB President Draghi speaks to the European parliament.
Still with Australia, the AUD rate decision (expected hold at 1.5%) is reported in the Asian session at 0330 Tuesday. US Trade Balance is released at 1330.
Wednesday sees the RBI rate decision on INR at 0900. The market is pricing in a 0.25% cut to 6%, and a hold would depress the currency and probably help NIFTY. Back to the UK, where the Brexit debate is scheduled to conclude, with a vote at 1900. The RBNZ rate decision (expected hold at 1.75%) is at 2000, with a speech by the Governor four hours later.
Thursday’s European session sees German imports, current account and trade balance at 0700 and US Jobless claims at 1330. We don’t cover MXN, but there is a rate decision at 1900, it is expected to rise from 7.5% to 8%.
Friday is a little livelier, an RBA monetary policy statement at 0030, and an EU extraordinary summit reporting at 0600. In the UK we have Manufacturing and Industrial Production growth at 0930 and the NIESR GDP estimate at 1500. Canadian employment and unemployment figures are at 1330. Also on Friday, Trump meets Japanese PM Abe, and if there are any ‘currency manipulation’ remarks, this may boost JPY against the dollar.