Many sound reasons to talk down the US dollar’s rally

By Shen Jianguang Source:Global Times Published: 2017/7/27 21:53:39

Illustration: Peter C. Espina/GT


Over the past year, I have often stressed that the US dollar's gains can't go on. Although the Brexit referendum in the UK and Donald Trump's victory in the US presidential election reversed the weak performance of the US dollar in the second half of last year, the cycle of the strong dollar, which has been prolonged, is turning because the US economy is not doing as well as expected and Trump's policies are facing obstacles.

I have been talking down the US dollar for the past year for a number of reasons.

First, US economic performance has fallen short of expectations. The market has overestimated the positive momentum of the US economy. What is really driving the market is the strong performance of the European economy.

In its World Economic Outlook report released in April, the IMF upgraded the economic forecast for major economies but its growth forecast for the US remained unchanged. In June, the fund even cut its 2017 growth forecast for the US economy by 0.2 percentage point to 2.1 percent. Consumption is a key driver of US economic growth, but retail sales fell in the past two months.

US manufacturing data has been mixed, with the Institute of Supply Management index rising to 57.8 in June from 54.9 in May, the best performance since August 2014. But factory orders fell 0.8 percent month-on-month in May, the largest decline since November.

The US job market generally remains stable. In June, 222,000 new positions were created, beating expectations while the unemployment rate held at 4.4 percent. But wages have grown slowly with hourly pay edging up a mere 0.15 percent in June. Meanwhile, consumer confidence has weakened, for example: the University of Michigan Consumer Sentiment Index fell to 93.1 in a preliminary survey in July, falling short of expectations of 95. Muted wage growth will take a toll on consumer confidence and inhibit consumption, which in turn will subdue US economic growth.

Second, Trump's policies have fallen short of expectations. At the end of last year, what drove up the US dollar was the optimistic outlook for Trump's policies. But I have always believed that the market was overestimating the strength of the Trump rally. If his policies fail to deliver results, it will push the US dollar to reverse its upward course.

Implementation of Trump's policies has been slow. Political scandals continue to unfold and then there is the failure of Trump's healthcare bill, along with delays in tax reform, and a debt stockpile from infrastructure investment.

A scandal involving Donald Trump Jr's alleged Russian collusion has added to Trump's woes. Some observers believe that Trump is facing a crisis and even compare the Russia's scandal with Watergate. These uncertainties will inevitably undermine the US dollar's value.

Third, inflation data in the US have been weaker than expected and the Fed has become more dovish. Inflation has an impact on the Fed's rate-hike road map, but US inflation figures are seen falling short of expectations, making a rate hike in September a low-probability scenario. The US Consumer Price Index (CPI) was unchanged in June compared with the previous month. On a year-on-year basis, the CPI increased by 1.6 percent, the smallest gain in nine months. The country's core CPI, not including food and energy costs, edged up a mere 0.1 percent in June from the previous month and recorded a 1.7 percent rise year-on-year, well below the Fed's 2 percent target.

Meanwhile, during a hearing of the House Financial Services Committee earlier in July, Janet Yellen reiterated the Fed's plans for gradual interest-rate hikes while emphasizing that the Fed would alter its plans if concern arose about persistent weakness in consumer prices. In comparison, the European Central Bank, the Bank of England and the Bank of Japan have recently stated that there is a possibility that they may wind down quantitative easing, which would allow for a weakening of the dollar.

Also, Fed rate hikes won't necessarily lead to a stronger dollar. A look back reveals that a weakening of the dollar has been a high-probability event in the wake of Fed rate increases over the past seven rate-hike cycles since the 1970s. There were two times that the rate hikes were accompanied by a brief dollar rally, which caused some difficulties for the economy and subsequently forced the Fed to alter its policies and turn to rate cuts.

Fourth, the European economy seems to be stronger than expected and black swan events in the political sphere have yet to occur. In light of this, the euro has rebounded 10 percent so far this year against the dollar. As the most heavily weighted currency in the US Dollar Index, which measures the value of the dollar relative to other select currencies, the euro's strong performance is considered a hindrance to the dollar.

European economic data point to robust growth in the eurozone. GDP growth in the eurozone hit 0.5 percent in the first quarter and the annualized growth rate was 1.7 percent, higher than the US performance for the same quarter, which indicates that the eurozone economy is already on a recovery trajectory.

Germany and France, the locomotives of the eurozone economic train, have shown marked signs of economic recovery. Even some of the countries that were deeply mired in crises such as Spain are on track to rapid rebounds and growth.

In the meantime, a gradual downtrend has been observed for political risks in Europe. The French presidential election didn't turn out to be a black swan event and there's a strong chance that Angela Merkel will stand for another term as German chancellor.

All these point to further dollar weakness, rather than the other way around.

The author is chief economist with Mizuho Securities Asia Limited.


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