Global Asset Management
National Bank of Abu Dhabi
Tel: +971 4 4245795
Dubai – 23 March 2017
There are reasons to continue to be bullish about the US dollar - despite current softness - and to see it as a good buying opportunity. Interest rate differentials should help the dollar, and the Trump Administration’s policies are expected to be rolled-out during the course of this year, looking beyond current perceived delays. A materially better, and pro-business environment should result. As predicted in NBAD’s recent Global Investment Outlook 2017 (GIO), this will not happen overnight though.
The US dollar, along with other US assets, has taken fright since the US Federal Reserve interest rate announcement last week. Fed Chair Janet Yellen reiterated her forecasts (to the disappointment of the more aggressive hawks) that three rate hikes are still expected for this year, along with three for next year. That would mean a Fed Funds rate of 2.25% by the end of 2018, versus the more benign expectations of ‘low-to-zero’ in Europe and Japan up to then. The extrapolated white dotted line (see Chart 1 below) shows the expected rate differential between the dollar and its major peers continuing to widen. This should keep the dollar underpinned, along with the gradually improving US growth story that we continue to expect, and borne out of what has been very resilient US economic data in recent months. It is true that European data has started to improve, although some remaining political questions remain to be resolved, in addition to the eurozone’s structural problems.
The orange line in Chart 1 shows the performance of the Dollar index (DXY), which has been in an uptrend since the start of the removal of US quantitative easing in 2014.
What started as only a small chance of a March rate hike earlier this year became near-certainty immediately before rates being hiked to 1% on 15th March. The tempered FOMC statement that followed disappointed some who thought the Fed might raise rates four (or even five) times this year, which would have seemed too extreme a normalization. In addition, the Trump reflation story appears to have given the market jitters due to a supposed lack of progress so far. The market had priced-in unreasonably rapid progress in the rollout of the new Administration’s policies. So the Dollar Index (DXY) has slipped back to the 99.80 level, close to the breakout point in late January when we advocated going long. Yet with the Fed’s ‘dots’ expected to show a faster rising rate path than other major currencies, there appears to be a disconnect between this and the recent behavior of the Dollar Index as per Chart 1.
Much has been said about Donald Trump’s presentation to Congress on his spending plans. Defence is an interesting case in point, which now includes an additional $30 billion budget adjustment sought for fiscal year 2017. There is also the extra $54 billion outlined for 2018. Defence secretary, James Mattis, will face senators on how this defence budget will be spent prior to it being approved. Meanwhile, Treasury Secretary Mnuchin has suggested not pressuring the current debt limit that was reinstated on 16th March (after a two year suspension under the Obama administration in 2015). Senate Democrats naturally keep threatening to block Trump’s policy priorities in Congress, leaving him to possibly use the debt ceiling as leverage later in the year. This has all conspired to hurt dollar longs.
In the end, however, we expect a good portion of Trump’s policies to be executed, not only in defence, but also many of the other measures outlined in his election campaign. Paul Ryan, the Speaker of the House, has certainly shown his willingness to work with the Trump Administration in Congress - something that was lacking under Obama, with then speaker of the House, John Boehner. Trump has hired some exceptional - especially financial - talent, and we expect these individuals to bring some interesting and very effective financing innovations.
Economically, the fact remains that US inflation has picked up. Consumer confidence has improved, the economic data is generally good, and we expect corporate capital expenditure (and M&A activity) to increase. In the markets, the rate differential argument (along with the Fed’s dots picture shown in Chart 2) shows an ‘on course’ picture that should keep the dollar in the uptrend that we postulated in the NBAD Investment Outlook 2017, and for the medium-to-long term. A ‘Dollar wobble’ may have occurred in recent days, but our earlier assumptions remain in place. We believe the current dollar softness represents another opportunity to go long.
In conclusion, we think the market had priced-in a short-term ‘Trump extravaganza’, only to be disappointed by the curtain for the First Act appearing not to rise. Much work is needed, yet certainly much is happening behind the scenes in the ‘dressing rooms’ of the White House. We believe investors should have confidence that a new, very business-friendly era based on the Trump Administration’s policies will soon become much more evident.
US Fed Funds (White), ECB Main Refi rate (Yellow), BOJ Overnight call rate (Blue) Dollar Index (DXY) (Orange line)– (Chart 1)
The US Fed ‘Dots’ Picture – (Chart 2)
|Chart source: Bloomberg
Weekly Investment View – 19 March 2017
Markets started the week in repositioning mode, ahead of an expected US rate hike. More hawkish members of the US Fed alluded to perhaps a more aggressive rate path in the so called ‘dots’ that outline the future path for US interest rates.
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