No such thing as a "sure thing" ? What about the dollar .....?

Friday 3rd March 2017

No such thing as a "sure thing" ? What about the dollar .....?

ref :- "Traders search for signals on dollar rally" , The Financial Times, Currencies Analysis, Markets and Investing

Back at the end of 2015, it seemed that the world and and his wife were confidently calling for further dollar strength into the new year. There was widespread faith that the economy would continue to grow at an increasingly faster pace and many felt that the consequent hikes in interest rates would by definition be supportive for the greenback. The US Federal Reserve even went as far as to predict four rate hikes in 2016. Of course we know now that they were all too optimistic. The economy experienced a familiar early-year stumble and the dollar spent the first five months of 2016 largely on the retreat.

A year or so on and expectations for  rates and the dollar are much the same in many respects, though for different reasons. Growth, employment and inflation gauges strongly suggest that the Fed will start tightening soon and the Fed's "three hikes this year" call, more hawkish than the market thought likely, now not only seems very possible but probably the most reasonable conclusion to draw. In fact, "two, maybe three" has suddenly become "three, and could it be four ?"  if you listen to various talking heads on the financial channels this morning.

That of course is a result of increasing conviction that a March hike, a 31% probability as recently as early last week and now rated as high as 90% by some measures, is on the way. That seems a fair assessment. We spoke the other day about how Fed officials, including the influential William Dudley of the New York Fed, were dropping some pretty unsubtle hints that the time to hike was nigh. But when arch-dove Lael Brainard effectively says that conditions for an increase have been met, as she did on Wednesday night, you've got to believe one's coming. 

Vice Chair of the Fed Stanley Fischer and Chairwoman Janet Yellen speak within half an hour of each other this evening, but whilst what they say will be interesting it's difficult to see them offering anything that would cast doubt upon the direction already offered by their colleagues. As we've noted in the past, Fed officials can irritate with contradictory messages but if they're all singing from the same hymn sheet, we can probably assume something's afoot.

So anyway, the dollar ..... Higher rates on the way at a faster pace so naturally enough, it's stronger. The Dollar Index, a measure of its value against a trade-weighted basket of currencies, is trading around 102.00  --  on Feb 2nd it made a low of 99.23. So it's higher, for sure ..... but not WILDLY higher. It hasn't reacted to the prospect of President Trump's reflation package in the way that the bond market has, and certainly not in the way of rampant, record-breaking stock markets. In fact, if you widen the lens a little, you'll see that the Dollar Index made a high of 103.82 at the turn of the year (3rd Jan, to be precise). If you were being very selective with your parameters, you could point out that the dollar has actually lost 1.75% in that time.

Of course, at the time of the New Year the dollar (and everything else) was caught up in whole Trump / Reflation Trade thing. It was all about how huge fiscal stimulus and tax-cutting was going to drive the economy to a growth rate of 3 - 4% , dragging stocks and the dollar along with it and pushing bond yields higher (and bond prices lower). It still is about that, but if equity markets in particular are happy to take promises of a truly comprehensive package on trust, perhaps currency traders feel in need of a little more detail. That would explain why the move in the dollar feels a bit muted.

Don't get us wrong here ..... on balance the most popular view is for the dollar to continue to appreciate. But right now it's the Fed driving the move, not the Trumpflation trade. What happens if and when the interest rate scenario is built into the price and the Administration still hasn't released details of its plans ? There is concern that too much time is being spent on border tariffs and trade disputes, not to mention brawls with the press, the judiciary etc and defending top-level personnel from allegations of misconduct, and not enough on doing what needs to be done.

As Stephen Jen of Eurizen SLJ Capital put it, there's "more shock than awe" to Mr Trump's policies so far. Mr Jen still thinks that despite the current "messy" situation the dollar will go higher in time. Well, why not ? Given known fundamentals and assuming what's expected comes to pass, it's the obvious call. But undeniably, as with most things, there's room for disappointment here. Speculative "long dollar" position holders will at some point need something beyond the Fed to maintain the faith, which is why they want Mr Trump to get on with it. In markets, there's no such thing as a foregone conclusion .... and even if they did exist, this isn't one of them.