Sitting in my office in Zürich last Thursday morning, my amazing view of the Alps got interrupted by a 7-strong helicopter flight, I realized it was President Trump and his entourage flying to Davos. The night before, Treasury Secretary Mnuchin had said in an interview: “A weaker dollar is good for us as it relates to trade and opportunities. Longer term, the strength of the dollar is a reflection of the strength of the US economy and that it is, and will continue to be, the primary reserve currency.” The press was quick to report on the first part of the quote, but failed to mention the second. To that extent, it was made to appear that the Dollar was being manipulated by the top government brass, resulting on the Dollar index dropping 2% on the news. Fast-forward a few hours, and the President gave an interview to CNBC’s Joe Kernan, where he said about Mnuchin’s comments: “I think they were taken out of context…” About the Dollar he said: “I don’t like talking about it because frankly nobody should be talking about it. It should be what it is, it should also be based on the strength of the country…”, and he concluded with: “…the Dollar is going to get stronger and stronger and ultimately I want to see a strong Dollar.” As soon as these comments was aired, the Dollar recovered most the previous day’s losses.
… the Dollar is going to get stronger and stronger and ultimately I want to see a stronger Dollar. – Donald Trump
But let’s backtrack a bit. Even before the latest events in Davos, the US Dollar had lost value against all major world currencies, albeit in different degrees of intensity. When we analyze the major drivers of currency fluctuations, we notice that most drivers actually point towards a higher Dollar as we can see below:
Rates?
No, rates are going up. Least we all forget our Economics 101, the theory of which clearly states that an increase in interest rates in one country with respect to another should drive the former’s currency higher in relationship to the latter’s. The US being one of the first major economies to start hiking rates, should be benefiting from a higher currency.
Outflows?
No. With the US Markets hitting record after record, large amounts of money are flowing into the US, which translates into more foreign currency being converted into US Dollars, which should be driving the currency up, not down.
Trade Balance?
OK, the US Trade Deficit has gone up in the last few years, and it is currently at around $50.5 billion, but it has flirted with that level several times in the past few years, and it is not a sole driver for the currency to drop.
Tax Reform?
The tax reform passed in December are likely to drive the Dollar up in the medium-term; however, it is strange that after the bill was passed, the Dollar has continued to fall.
But the Dollar keeps falling against the major currencies. The Dollar Index has dropped to fresh new lows, down from its highs above 101 to lows of around 89, with strong support at 80. And that was before last week’s drama at Davos, but the question remains why? Maybe we need to look not at traditional driver, but at the currencies against which the Dollar has dropped the most, and evaluate each pair in its own right.
Euro:
The Euro was under pressure against the Swiss Franc, when the SNB decided to unpeg its currency from the Euro, then came Brexit, and then Trump. This developed a level of unease among the Euro-zone that new populist or extreme right-wing governments would follow suit in Netherlands, France, and who knows, even Germany. These fears never materialized, and the Euro has had a solid run since Macron’s victory in May of last year, and was further propelled by the outcome of the recent coalition talks in Germany that would secure a fifth term for Angela Merkel as Chancellor. The Euro has been strengthening not only against the Dollar, but against most other currencies: It recently tested the 1.1825 resistance against the Swiss Franc, meaning it has increased nearly 20% in value against it, since the lows in January, 2015. The only anomaly would probably be its behavior against the Pound Sterling, which we will discuss later.
Sterling:
After a precipitous drop in the aftermath of Brexit, the Pound continued to lose value against the Dollar all the way to the all-time low of 1.20 in January last year. From that point, the recovery for the following months was steady making up its losses all the way to the mid-1.35s, and picked up some serious steam earlier this month pushing it to 1.42 against the Greenback, breaching the pre-Brexit floor. The technicals show a steady and unchallenged path to the 1.47 level. The question is why? Was it the statement that “sufficient progress in the Brexit talks” had been achieved, which would allow to start the next stage of negotiations? Was it the notion that Britain is marching towards a “softer” Brexit? Or was it the fact that the markets noticed how strongly they overreacted to the vote, and now are believing like David Cameron recently put it “Brexit is a mistake, not a disaster”. Either way, the Cable’s recovery has been backed by some gains against other currencies as well, not least the Euro where it has advanced from all-time lows of 1.08 to twice testing the 1.148 resistance level.
Swiss Franc:
With negative interest rates, and an artificial peg that was eventually dropped, Switzerland can’t do more to keep your money away. Yet, for a while, the world kept bringing their money to Zürich and Geneva. Today, the Franc is off its recent lows against the Euro, but still very much lower than its peak in 2015. Which makes us wonder about the Franc’s relationship to the Dollar… The Franc has penetrated in a bullish manner the recent 2-year support at 0.95, and looks to be in free-fall. Next stop, 0.91.
Conclusion:
Strong fundamentals, and expected future developments in the US economy all suggest a stronger Dollar. A strong reassurance from the President doesn’t detract from that statement. So. we should expect some strengthening of the Dollar during 2018, whether it’s driven by the US, the other countries or simple mean-reversion, but maybe we’ll see some further short-term depreciation before it bounces.