As is so often the case, one of 2017's consensus trades for went into reverse in the opening weeks of January. The US dollar suffered its worst start to a year for three decades, falling more than 2.5 per cent against a basket of currencies and having an impact in turn on assets including emerging market securities, gold and other commodities.
The move could be more than a temporary blip after a two year period in which the dollar index rose 25 per cent. Predicting the path of a currency is never simple, but investors believe there is now an added complication when considering the outlook for both the greenback and the securities affected by its fluctuations.
Traditionally, global demand for dollar assets and the respective directions of fiscal and monetary policy have played the largest roles in driving the currency. But it is another factor that is perceived to have sparked the latest sell-off: the words, rather than the actions, of the Trump administration.
In a break with the country's decades-long "strong dollar" policy, President Trump and his cabinet are known to want a weaker currency in order to aid US competitiveness and so improve the country’s trade deficit. In the latest in a long line of comments, Trump said in January that dollar strength was “killing” US business, while in February his trade adviser, Peter Navarro, claimed Germany was taking advantage of a “grossly undervalued” euro.
The President’s promised policies, however, are likely to work against his currency wishes. Basic economic theory suggests that reducing the trade deficit would strengthen the dollar. A fiscal stimulus programme launched at a time when employment levels are relatively high would likely be inflationary as well as increasing the budget deficit; encouraging companies to repatriate overseas cash piles would also be a tailwind for the currency.
Then there is the Federal Reserve. Having hiked interest rates last December, it is expected to do so twice more at least this year. That should give further impetus to the dollar at a time when most major central banks remain in loosening mode.
In the absence of any concrete fiscal policies, it is talk, not actions, that has won out so far this year. That is partly because the “Trump trade” which gained ground so quickly in late 2016 saw investors price in fiscal stimulus but seemingly ignore the president’s implicit commitment to stoke trade tensions.
“Dollar bulls are bailing out almost as fast as bond bears,” Kit Juckes, currency strategist at Societe Generale, said earlier this week. He noted that speculative long dollar positions had fallen sharply at the start of February.
With the dollar having hit a 14-year high last December, the sense is that the risks may have shifted to the downside in the near-term. That would help the likes of emerging markets continue their recent run, but not everyone is convinced.
“Long-dollar positions for the time being are going to be pretty disappointing. But we’re not sure whether that’s the end of the bull market,” Investec Asset Management’s Philip Saunders said. His colleague John Stopford added that most Mr Trump’s policies are “dollar supportive”.