Inaction and downside dollar/euro risk
- Dollar downside beckons as Trump trade future yet to crystallise
- Downside risk also continues to dominate euro agenda
- Macron cements position as French president in waiting
- Mid-term sterling prospects likely to outstrip euro
By Neil Staines
“I never worry about action, but only inaction” — Winston Churchill
At the end of January, we argued the case that in our view it was unlikely that dollar would strengthen significantly until president Donald Trump delivers on his promised fiscal loosening and infrastructure spending. Indeed, we suggested that the short-term risks to dollar were likely to the downside, at least until he does.
Since then, despite the heightened political concerns in the Eurozone, the signs of further economic slowdown in China and even a rate rise in the US, the USD index is now lower (albeit only marginally). Furthermore, we now see the short-term risks to the downside for dollar as more acute.
Theoretically, tighter monetary policy and looser fiscal policy should be a classic scenario for currency strength. However, the Federal Open Market Committee and the administration have been quick to point out their lack of support for a stronger dollar. The Fed have done so on the grounds that a stronger greenback dents growth and weakens inflation. The administration on the grounds that it weakens ‘fair’ trade and costs US jobs.
While the Fed raised interest rates in March, it did so at the same time as downgrading its economic forecasts over time. Despite the fact that Fed speakers have begun to suggest business investment is picking up, and rates are rising, the biggest boost to US productivity and thus longer-term growth can only come from implementation of structural reform and infrastructure spending. Therefore, increasing concern over the potential risks to the congressional agenda, against the current global reflation, likely equate to downside risks for dollar.
“It was impossible to get a conversation going, everyone was talking too much” — Yogi Berra
From our perspective, downside risks are also dominant for Europe and for euro. The procrastination and inaction of the Eurozone was again highlighted yesterday as Eurogroup head Jeroen Dijsselbloem stated that “key Greek issues need talks”. In our view, this procrastination and inaction is a major driver of the key risks to Europe and the Eurozone.
European Central Bank president Mario Draghi has been pleading with national governments to enact structural reform since the ‘breathing room’ he provided the periphery states with the “whatever it takes” speech in 2012. Banking reform (and balance sheet consolidation / reform) is another example of the outstanding and much needed action across the eurozone.
Last night, an historic presidential debate took place in France between the top five candidates ahead of the first round of the election in just over a month’s time. An immediate response poll suggests Emmanuel Macron was deemed the most convincing and polled significantly higher on the questions such as “Who has the best plan for France?” and “Who has the best qualities to become the next President?” EUR rallied as a result. From our perspective, none of the candidates offer the kind of reform (or even action) potential that the dormant power of France is so badly in need of.
“Trade deals are meant to create win-win situations” — Angela Merkel (March 20)
In the UK, Prime Minister Theresa May announced Monday that Article 50 will be triggered on March 29, firing the starting gun on the two-year period of ‘Brexit’ negotiations. The ultimate goal for both sides in a negotiation should be to secure the best terms possible for each other. Indeed, the whole ethos of global trade is build around the concept of mutual benefit. Attempts to punish the UK or to aim to make the UK worse off as a result of negotiations goes against all that global trade objectives stand for.
Most importantly, it is not countries and certainly not unelected European bureaucrats that facilitate and engage in trade, it is companies. We would argue that the motivation of these companies will continue to engage with one another in mutually beneficial trade - not the pursuit of a political agenda to make sure that the UK is worse off outside the ‘club’. If ‘punishing the UK for leaving the EU does become the focus of negotiations, then it will likely damage EU trade and its credibility, both internally and externally.
The biggest threat to the EU and the single market is not the UK leaving, but prolonged economic decline. From our perspective, the best way of ensuring growth and stability of the EU is through a comprehensive free-trade agreement with the UK.
From an FX standpoint, we continue to favour sterling over the common currency from a more medium-term perspective as positioning, expectations and and valuations appear overstretched on the negative side for sterling, particularly if, amid rising inflation, the UK economic deterioration that so many economists have forecast, then delayed, fails to materialise… again.
In terms of dollar, and the downside risks we allude to above, USDJPY is likely the barometer of such sentiment. From a technical perspective, it is likely that later this week the crossing of the 50- and 100-day moving averages will provide a negative signal for this currency pair. Our tendency to utilise technical signals in the timing of expression of fundamental views will likely come to the fore this week.
— Edited by Martin O'Rourke
Neil Staines is head of trading at The ECU Group