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”.
A watching brief is also advised by Kames Capital multi-asset head Scott Jamieson, who describes the dollar’s recent reversal as a “constructive consolidation”.
Others, such as Pictet Asset Management chief strategist Luca Paolini, have committed more forcefully to a period of dollar weakness.
“There could be more dollar depreciation to come and so we have increased our European currency weightings, taking the euro, sterling and Swiss franc to overweight from neutral against the greenback,” Mr Paolini says.
It is not just the Trump administration’s comments which could weigh on the currency. The familiar sight of new-year weakness in US economic data, such as disappointing wage growth, may yet prompt the Fed to hold fire once again on further rate hikes – particularly as it attempts to gauge the intentions of a confrontational White House.
Mr Juckes believes there is a more conventional reason for the dollar dip: movements in US Treasury yields. This does not disavow the link with the White House – stimulus means stronger growth, which in turn makes Fed hikes more likely – but it is a simpler theory to digest.
“It’s hard to see where the dollar-bashing rhetoric is having a major impact…the dollar’s correction in recent weeks can largely be explained by the pullback in US real yields”, he said.
A more widespread belief in this relatively straightforward relationship would soothe investor concerns. But worries that Mr Trump’s rhetoric could produce more serious currency or trade skirmishes remain in the ascendancy for now.
