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First 100 days - can it be that the USD only goes higher this year?

Donald Trump has taken office with much fanfare and it is fair to say the next 97 days will occupy trader and investor minds alike.

USD
Source: Bloomberg

There is a view from certain circles that the USD over the coming 12 months (which, along with the US ten-year treasury, has become the must-watch market for 2017) will only go higher.

The simplistic argument behind this view is that we are going to see higher inflation expectations pushing the Federal Reserve to hike three times this year. Obviously, this would be down to a successful roll out of tax cuts, infrastructure plans, and a tax repatriation holiday and of course, less regulation through a repeal or amendment of Dodd-Frank.

The other view for a higher USD is that we are going to see protectionist measures, which in turn will cause a wave of capital to be repatriated by US companies.

Morgan Stanley coined the phrase ‘a good USD and a bad USD’. The path the USD takes will determine the label. This is certainly an interesting view - if you believe the theory, it could shape a longer-term directional bias for the USD, which of course FX traders will need to trade in and out of. Certainly, the USD basket is technically back testing the neckline, so a rejection of this level from here would provide traders with a far better entry point if the USD genuinely can only go higher!

USD
Click to enlarge

As Trump starts his first 100 days, the headlines are rolling in, making it almost hard to keep up. The narrative around tax has been widely discussed, and we are now hearing about approximately 50 infrastructure projects totalling $137.5 billion. We have seen President Trump sign an executive order in support of the Keystone XL pipeline and Dakota Access pipelines, subject to ‘terms and conditions’, where these projects are expected to create tens of thousands of jobs. There have also been discussions around Trump meeting US automakers urging them to boost productivity.

This is exactly what traders need to hear, because the 4% decline in the USD from 3 to 23 January was premised on traders reducing a rather large USD-long position, amid a lack of patience in the understanding of Trump’s fiscal policy initiatives. What we are seeing first hand is a president who wants change in America and wants it quickly. The market will warm to this urgency. Let’s not forget that Trump’s economic team are more in tune with financial markets than any other administration, given the level of ex-Wall Street executives.

So, as we get further clarity on policy, I think it’s important to understand what to look out for in driving the USD into a ‘good’ or ‘bad’ USD camp. Clearly, the smoking gun and poster child of all things protectionism comes with the Trump’s administration relationship with China. 45% import tariffs are not going to be taken well by markets and while the idea is to boost US corporates activity domestically, the impact of a sharp tightening of financials conditions could seriously damage the US economy. Tread carefully when the feedback loop of tariffs on China could ultimately mean a weaker US economy.

It is also worth keeping in mind that we get the next US Treasury FX report in April and there could be some tensions ahead of this meeting. If Trump can convince Steven Mnuchin and the US Treasury department to label China as a currency manipulator, this may cause angst in the market. USD/JPY would be sold initially as traders seek the safety of the JPY, but could reverse on the idea of capital repatriation into the USD.

On the reflation side, we need to see signs that businesses are responding and that there are wild, insatiable animal spirits which can drive increased productivity and investment. This is how we get to 4% annual growth and potentially 25 million jobs over the coming decade, even though the figures are rather optimistic. This means watching key economic data points that highlight domestic demand. These include the National Federation of Independent Business (NFIB) small business optimism index, capital goods orders and the new orders sub-component of the monthly services and manufacturing ISM. Expect these data points to get much greater attention from here.  

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