Has Donald’s dollar drive got legs?

The bullish dollar picture has been muddied somewhat after Michael Flynn quit his post. Are we going to see another push higher or a reversal for the greenback?

Donald Trump
Source: Bloomberg

There is no doubt that Donald Trump’s early months in power have had a profound effect on financial markets with the Dow Jones hitting all-time highs, and the dollar reaching levels not seen since 2003. However, amid this sharp appreciation in the greenback, it is worth asking whether these gains can be sustained. 

The story behind much of this appreciation is related to a handful of policies promised by Trump either before or after his victory. Most notably, the investor anticipation has been heightened by Trump’s promise of a large fiscal stimulus package. This, funnily enough, represents one of the few elements of Trump’s campaign that has been largely neglected in his first weeks in the office, but that might be a blessing in disguise. After all, it means that one of the biggest boosts for the dollar could be yet to come. 

On the monetary policy side, it is worth noting that the expectation of greater growth, coupled with rising inflation provides an environment where rates are going to have to rise relatively frequently. Janet Yellen told us as much. That growing differential between the US rates on offer vs nations with rock bottom (or negative) rates will be a key driver of trade going forward. Provided we see the US continue on its current pathway, coupled with the continued low rates elsewhere, this could drive the dollar’s strength for some time. Political concerns across the EU, and the failure of Abenomics to achieve target inflation means that we could be years away from hikes in many of these countries.

That being said, we are seeing a growing threat which was originally set into motion when Michael Flynn left the role of national security adviser after it turned out he had been contacting Russian officials ahead of taking office. The press is certainly no fan of Trump, and nor is the US intelligence community. We are now seeing a growing investigation into ties between Trump and Russian officials, where a big revelation could throw his presidency into disrepute. This is certainly a threat to the dollar, but if Trump can ride this storm, it is likely his policies will drive the dollar once more.

Looking at the technicalities, we have seen the price break back below the crucial $100.78 level last month, and it is the ability to break back above that level that is going to be crucial. Last week saw a strong rebound for the dollar, yet we are now seeing those gains fade somewhat. The ability to break through $100.78 is going to be key to tell us that we are set for another leg higher for the dollar index. However, the fact that we are seeing the stochastic break below 47 is a worry, given the wedge breakdown last month. Whether that bearish signal comes to fruition is yet to be seen, yet the fact that has occurred is certainly not bullish.

DXY weekly chart

On the four-hour timeframe, we have dropped out of an ascending channel, bringing about the potential for weakness. With the price passing through the $100.52 level, it does look like we could see further downside to come over the short term. We would need to see a break through $101.69 to negate this channel break. 

DXY four-hourly chart

This is a case of the technicalities showing us a different picture to the fundamentals. The growing discourse around Trump’s Russian ties during the election raises the risks associated with the US dollar. However, barring any major shocks, which undermine his position, Trump is likely to continue implementing policies positive for the dollar. That, in turn, should drive a more hawkish Federal Reserve, thus widening the rate differential and increasing the attractiveness of the greenback as a carry trade.

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