Two Surprises With Different Currency Results

November 30, 2016

2016 will be remembered politically for the British referendum vote in late June to leave the European Union even if such means weaker British economic growth in the long term and the U.S. election in early November of Donald Trump, the significance of which remains quite uncertain. Sterling has fallen, but the dollar has climbed in the wake of these two populist voter decisions.

Sterling’s reaction made a lot of sense. Britain is going to lose many of the benefits of belonging to Europe’s single market. Financial services, which generate a disproportionate share of U.K. value added, is a sector that may take one of the largest hits. The status of Scotland and Northern Ireland remaining part of Great Britain for the foreseeable future can no longer be taken for granted. The Bank of England’s initial reaction to the Brexit vote was to halve the Bank Rate and to resume quantitative stimulus.

America’s embrace of a strongman president is the  more intriguing story. A debate still ranges over whether Trump will deliver on his radical proposals, which represent an enormous overhaul to America’s role in the world and many domestic programs as well. Those characterizing the president-elect as more pragmatic than ideological anticipate a moderate agenda. Others counsel that it would be a mistake not to expect Trump’s big plans to be implemented in full. This ambiguity stems from Trump the campaigner’s lack of detail and his seeming inconsistency on some key issues where positions sometimes changed. Also, he has announced candidates with traditional Republican ties and those on the edge of the party. History suggests that in political revolutions initially including extremist factions and voices of moderation, the radicals usually end up on top.

If that generalization holds in the United States over the coming two years, the dollar’s rise may prove temporary. The U.S. government will take an insular approach in trade policy and on immigration. High dollar competitiveness could be sought at all cost. The Fed’s independence from political pressure is likely to be attacked, and that usually weakens currencies. In other countries led by strong populists, like China, Russia and Turkey, economic growth has slowed, and currencies have weakened.

Barring interference, a downturn in the dollar does not look imminent, however. 2017 will be a year of more U.S. fiscal stimulus and more than a single interest rate hike by the Fed. The ECB and BOJ will not follow the Fed, because the economic circumstances in Europe and Japan are different to America’s. Left to market forces, the dollar ought to be well bid, but the wild card is that the Trump administration may not adopt a hands-off stance to dollar strength. In Reagan’s first term, appreciation was interpreted as market confidence in U.S. economic policy, and the dollar was permitted to rip upward. In the first term of Bill Clinton’s presidency, in contrast, officials waged a rhetorical barrage criticizing Japanese trade practices to drive the yen upward.  That approach could happen again.

Fifty weeks have elapsed since the first and so far only hike of the federal funds rate in this cycle. Monetary officials intended to do more initially, but on-year GDP growth slowed to 1.6% in 3Q16 from 2.2% a year earlier and 2.9% in the year to 3Q14. Employment grew more rapidly and faster than Fed officials were expecting, but the jobless rate held only steady. Comparing financial market signs between the time of that only rate hike and the New York close in November, the dollar had dropped 6.1% against the yen but climbed 3.4% versus the euro. It also rose in trade-weighted terms. The 10-year Treasury yield, which climbed very sharply so far this quarter, is only ten basis points higher since the Fed tightening. Both oil (+36.7%) and gold (+9.3%) have climbed considerably.  Home prices are higher, and the DOW has risen 8.8%. A 1.4% drop in non-residential investment between 3Q15 and 3Q16 is disappointing and follows increases of 1.4% in the year to 3Q15 and 7.7% in the year to 3Q14.

The month of December will be a time of waiting for the yearend holidays but also the fast-approaching installation of a new face to America. How the dollar moves will be a barometer of investor sentiment regarding the regime change.

Copyright 2016, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



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