The U.S. dollar continued to recover from a five-month low against the Yen early Tuesday, after testing 108.11 yesterday. Comments from U.S. Secretary of the Treasury Steven Mnuchin, stating that a strong dollar is good in the long run, offset previous remarks from President Trump who last week said that the dollar is getting too strong and that it is hard to compete when other countries devalue their currency. However, Mnuchin also agreed that the dollar’s strength in the short run is hurting exports and the economy;based on such mixed signals, traders are finding it difficult to choose on which side to take a trade.
Since both the U.S. President and Secretary of the Treasury agree that the greenback is overvalued in the short-term perspective, dollar bulls shouldn’t get overexcited on the long run views. Instead, I would suggest ignoring what politicians are claiming for the time being and to focus on what most recent economic data is saying:
- U.S. inflation expectations fell to their lowest levels in 2017
- Retail sales fell for a second month in March
- Consumer prices dropped for the first time in over a year
- Atlanta Fed cuts U.S. first quarter GDP to 0.5%
- U.S. non-farm payrolls marked the smallest gain since May 2016
This set of most recent economic hard data indicates that the robust soft data reflecting consumer and business sentiment didnot translate into spending, investing and hiring. There’s a clear gap here and such a divergence may not last for long. Either hard data should agree with sentiment surveys, or optimism will start to fade.
Mnuchin sent another signal on tax reforms on Monday, saying that expecting one before August is highly aggressive and not realistic. Investor and traders are likely to start questioning whether Trump will be able to deliver on tax reform and stimulus but so far most signs are negative, thus another negative factor affectingthe USD.
Expectations of a wider divergence in monetary policy also took a hit. Markets expectations for a June rate hike have fallen below 50%, down from more than 60% just a week ago according to the CME FedWatchTool. Moreover, chances of two rate hikes in 2017 dropped below 40%, so traders betting on interest rates differentials should tweak their model assumptions.
Overall, there’s a high chance that the dollar could have already topped out for the year, but whether more declines willbe seen relies heavily on fundamental drivers, not verbal interventions. I would prefer selling the rallies than buying the dips on the short-run until we see solid evidence of U.S. fiscal stimulus.
