Talking the dollar down, or is it up?
Feb 1st 2017, 12:15 BY BUTTONWOOD
IF THERE was a consensus view at the start of the year, it was that the dollar would rise. Fund managers surveyed by Bank of America Merrill Lynch were overweight the currency (even though they worried that it was a crowded trade).
The stars seemed aligned in the greenback's favour. The Federal Reserve was set to raise rates, while other major central banks were keeping monetary policy loose; that should boost the dollar's attractiveness in terms of yield. The new Trump administration was set to unveil a fiscal stimulus and boost growth; that should encourage those who wanted to buy American equities or invest in American factories. And tax proposals were designed to persuade American companies to repatriate overseas profits, giving the dollar a further lift.
So why has the dollar retreated to hit a 12-week low? The main reason is the rhetoric of the new administration. Mr Trump told the Wall Street Journal that
Our companies can't compete with them (Chinese companies) now because our currency is too strong. And it's killing us
As David Bloom of HSBC points out
Not only did this point to a break with the long-running mantra that a strong USD is in the US interests, but it threw out the convention that it is for the US Treasury, not the president, to opine on USD policy.
And it's not just China that the new administration is complaining about. Mr Trump's trade adviser Peter Navarro told the FT that
Germany...continues to exploit other countries in the EU as well as the US with an ‘implicit Deutsche Mark’ that is grossly undervalued
While it is true that Germany has a big current account surplus, only someone who has not read the paper for the last 15 years could argue that Germany has been trying to drive the euro down. Germany only accepted the euro as the price of further EU integration; it would have preferred to hang on to the mark. The Bundesbank has consistently opposed additional stimulus from the European Central Bank. Wolfgang Schaeuble said last year that
It is undisputable that the policy of low interest rates is causing extraordinary problems for the banks and the whole financial sector in Germany
So do the Trump team think the euro is too weak? Marc Chandler of Brown Brothers Harriman points to another element in the rhetoric
Ted Malloch, who is widely tipped to be the next US ambassador to the EU (and presently a professor at Henley Business School at the University of Reading) is a Eurosceptic. He said he wanted to short the euro and intimated that the eurozone could collapse in the next 18 months.
And then there is Steven Mnuchin, the next Treasury secretary. He seemed to backtrack from Mr Trump's comments, saying
When the president-elect made a comment on the US currency, it wasn’t meant to be a long-term comment
Too weak, too strong; which is it? It all adds up to incoherence. Here is Vasileios Gkionakis of Unicredit on the Navarro statement
This is quite strong and unusual rhetoric coming from a very senior trade adviser to the US president. First, and since it comes just days following the president’s comments about the “too strong" dollar, it suggests that the US administration sees the exchange rate as one of the main anchoring points for the deployment of its trade policies. Secondly, and perhaps more importantly, it adds an additional layer of confusion and inconsistency in this twisted web of incoherent policies: a shift towards a “weak dollar policy” is at odds with the imposition of tariffs (which tend to lead to exchange-rate appreciation – ignoring for the moment the possibility of retaliation). And needless to say, a stronger USD is difficult to reconcile with the creation and protection of manufacturing jobs domestically. So the market smells political inconsistency…and this is happening at a difficult point for the dollar
It is worth noting, of course, that countries can talk down their currencies but this can only work for a while. HSBC's David Bloom again
So it is possible that Trump will continue to express the merits of a weaker USD but rhetoric loses its potency after a while unless it is followed up by action to deliver that depreciation. One only has to look at Japan’s experience. Frequent expression of discomfort by Japanese policymakers with JPY strength during Q3 16 seldom had a lasting impact because it was never followed by action.
The key is interest rate policy. Before the election, Mr Trump said Janet Yellen was keeping rates low for "political" reasons and should be "ashamed" of herself. Many people were inclined to ignore this rhetoric, arguing that Mr Trump, whose companies have declared bankruptcy many times, would not really be keen on higher rates. But many in the Republican party have also been sceptical of Fed policy, particularly of quantitative easing. there are two Fed vacancies to fill and Ms Yellen's term runs out in 2018 so new appointments may push the central bank in a more hawkish direction.
But that would push the dollar up, not down. You can't have a stronger economy, a more hawkish dollar and a weaker currency. But these trade-offs have yet to be faced squarely. In the meantime, markets are understandably confused.
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