US dollar swings from bump to slump as Trump farce unfolds

A chaotic White House is sapping the strength of the dollar, as hopes Trump’s policies will fuel an economic boom fade.

A trader works on the floor before the closing bell of the Dow Jones at the New York Stock Exchange. (AFP PHOTO/Bryan R. Smith)

Perceptions of the health of a nation’s economy can be reflected in the strength or otherwise of their currency. With the US dollar apparently in free fall, it is apparent that the markets disagree with Donald Trump’s assertion that there is no chaos in the White House.

It seems an eternity ago (it was only in January) that Trump blamed the market’s confidence in him and his policies for a surge in the US dollar that was a component of the “Trump Bump” that followed his surprise victory in last year’s presidential election.

The US dollar ran up about 11 per cent against its major trading partners’ currencies between the election and the days ahead of his inauguration. Since January, however, it has lost about 10 per cent of its value against that same basket of currencies. It’s now back to levels seen at the start of 2015.

Hedge funds, which had held net long positions in the dollar as recently as the start of May, now hold net short positions, betting on further falls.

If the rationale for the Trump Bump was that the US economy would boom as his platform of tax cuts, infrastructure spending, aggressive trade policies, healthcare reform and deregulation was implemented, it is obvious why the dollar has fallen.

The daily drama, or should that be farce, in the White House and the inability of the administration to get its key healthcare policies past first base in Congress has raised a massive question mark over its competence and its ability to implement any of the key planks of Trump’s agenda that markets had embraced so enthusiastically.

The US stock market has held up at near record levels and US bond yields remain at historically low levels despite signals from the US Federal Reserve Board that it could start shrinking its balance sheet in September, withdrawing liquidity from markets, and is still contemplating a third rate rise for 2017 before year-end.

Equity and bond investors — and currency traders — appear to be betting that the doveish tone of Fed chair Janet Yellen and other board members concerned about soft inflation readings will see the start of the next phase of normalisation of US monetary policy delayed. The markets are in for a rough time if they have miscalculated.

In the meantime, the decline in the value of the US dollar is spawning a fresh burst of carry trade activity that is exporting deflation to other economies, impacting other markets and complicating monetary policies elsewhere.

The Australian dollar, for instance, started the year at US71.84 cents. It’s now above US80 cents, an 11.5 per cent appreciation. While there was very little prospect that the Reserve Bank would have raised Australian interest rates this year, the spike in the dollar has ensured there won’t be a rate rise.

The Europeans are starting to worry about the appreciation of the euro, just as the eurozone was showing real signs of life. With the euro at two-and-a-half-year highs against the US dollar, its strength will depress corporate earnings and activity and complicate the European Central Bank’s task of trying to gradually diminish the scale of its interventions in fixed interest markets.

In fact, the spillovers as those who piled into the US in the post-election period shift their trades elsewhere are having a global impact, with the carry trades fanning out across the globe and across markets searching for positive yields.

Those trades are pushing up commodity prices because they lower the raw material and financing costs for China in particular but developing economies more generally.

For the Australian dollar, there is both the commodity impact and the fact that Australian interest rates, while historically low, offer better yields than their US or European counterparts.

It’s not surprising that Canada, which also has a big resources sector and which has just raised official interest rates for the first time in seven years, is also seeing a big surge in the value of its currency.

The slump in the value of the US dollar is obviously good for US exporters and multinationals with large offshore operations but not such good news for domestic businesses reliant on imported products or components. It works against a key element of Trump’s “Make America Great Again” economic agenda.

The trajectory of the US dollar, and probably equity markets, could be reversed either by a crisis — traditionally funds flow towards the perceived safe haven of US Treasuries in any crisis — or by the Fed following through on its plan to begin shrinking a balance sheet bloated by its quantitative easing policies in the post-crisis period and signalling more rate rises this year and next.

Sharemarkets trading at or near record levels aren’t pricing in a gradual normalisation of interest rates by the major central banks, nor do they or bond markets appear to be pricing in any meaningful level of risk.

For the moment, Trump is able to, and does routinely (“highest stockmarket EVER”), refer to the US sharemarket as an indicator of the continuing confidence in his administration.

If the administration continues to be dysfunctional and unable to prosecute its agenda and if the Fed starts winding back its holdings of bonds and mortgages and continues to signal another rate rise this year, he might need to find another reference point.