Dollar Determinants to Watch

October 16, 2017

Dollar/yen has been a more stable relationship in 2017 than the EUR/USD pair. Monthly averages of the yen from February through September were confined within a three percentage point band with a dollar high of 113.04 in March and a low of 109.77 in August. The mean so far this month likes within that range but closer to the dollar high than low. The euro, in contrast,  strengthened cumulatively from a December 2016 average of $1.054 to a mean last month of $1.191. The last calendar month in which the the euro on average was worth $1.200 or more occurred in December 2014.

Right after the 2016 U.S. election, the dollar and U.S. share prices rallied. While stocks have continued to trend upward in 2017, President Trump’s unpredictability has dampened the dollar somewhat. Promised legislation has so far failed to materialize. The Republicans attach high importance to the need for at least one significant piece of legislation before the 2018 mid-term elections, and tax reform would be one that would likely elicit a positive dollar reaction initially.

Meanwhile,  U.S. growth has strengthened, unemployment is closer to 4% than 5%, and the federal funds rate was raised three times between December 2016 and June 2017. Trump’s views on trade are consistent with a desire to maintain the dollar at competitive values. The goods and services trade deficit in June-August averaged $43.165 per month, a tad more than $3 billion from the mean during the first five months of the year. But lower inflation than expected provides cover for the Fed to tighten policy only gradually and has kept otherwise positive economic fundamentals from lifting the dollar.

An important currency market factor during the year ahead concerns possible leadership changes at the Fed, Bank of Japan and European Central Bank. Janet Yellen’s term as Chair of the Board of Governors expires on February 3. Being 71 and an Obama appointee, I do not think Trump will nominate her to serve a second 4-year term. Yellen is better trusted in world financial markets than other candidates for the job. Until and unless perceptions of her successor improve, the replacement of Yellen would probably affect the dollar somewhat adversely. More Fed interest rate increases and a gradual reduction of the Fed balance sheet will probably happen regardless of whom Trump selects.

Haruhiko Kuroda’s five-year term as Governor of the Bank of Japan ends on April 8, 2018. There’s some talk that Kuroda, now 73, could be reappointed, but that would break tradition. Kuroda has steadfastly resisted calls for less quantitative stimulus, which Prime Minister Abe also supports. But replacing Kuroda would provide an opportunity to try a different monetary policy approach than the one that for the past three years has failed to deliver a sustained 2% inflation rate. The dollar is a lot stronger against the yen than it was at the start of Kuroda’s time as BOJ governor. If he were to be replaced, the yen just might strengthen.

European Central Bank President Draghi, now age 70, is about to begin the final year of his eight-year stint in that role. His stewardship ends in November of next year. Draghi has been a proponent of very easy monetary policy until the inflation target of below but close to 2% is more assured of achievement than now. Some members of the common currency area want the bank to steer a quicker normalization of policy than Draghi supports, but his replacement will likely exert less foreign exchange market influence that the replacements of Yellen and Kuroda for the simple reason that the ECB President has less institutional dominance over policy than his U.S. and Japanese counterparts. That said, the perceived competence of the ECB President in the longer run is very important to the health of the euro. The first leader of the ECB, Wim Duisenberg, was not a particularly good communicator of policy to the public and failed to secure full market trust. The euro fell from $1.1820 at the start of 1999 to a low of $0.8228 late in October of 2000.

Copyright 2017, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



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