Global financial markets have
been all over place, when it comes to pricing ‘Trump Effect’, majorly because
of the very nature of US president. US equity markets, which were trading with
weakening bias ahead of US election results, have rallied more than 10% after
Trump’s victory. Financial markets started to price in higher fiscal push and
improved inflation in US markets, leading to rally in US dollar and bond
yields. The US dollar index had rallied to 103.50 levels, last seen in 2003,
amid expectation of higher inflation and sharper tightening of US FED monetary
policy. Though, US dollar has corrected a bit after President has raised his
concern over stronger dollar, it seems that more uncertainty in US trade and
government policies is likely to provide support to US dollar.
Trade Balance Impact: US has been running huge trade deficits for
decades now. But it has little impact on the value of US dollar. For instance,
since July 2014 US dollar index has
rallied more than 25% despite trade deficits of more than $500 bn per year. Chart
below indicates the Balance of payment position of US for period Jan-Nov’16 US
has a net balance of payment deficit of $ 677.09 Bn, which is majorly
contributed by China, Mexico and European Union. A stressed trade relationship
will have comparably less impact on US dollar than its counter-parts.
Monetary Policy: Most of US dollar rally, in last two and half
year, can be attributed to diverging monetary policy between US FED and the
rest of the central banks. ECB and Bank of Japan have been printing loads of
money to fuel domestic growth & inflation. Though, inflation has just shown
delayed signs of improvement, sharp decline in currencies has rendered support
for retaining wallet share in world trade. In case of declining world trade,
ECB & Bank of Japan can act more swiftly to adjust their monetary to secure
their wallet share. The ECB and Bank of Japan would be better placed to
depreciate their currencies, of-course unintendedly than US FED. As US FED is
less likely to take a U-Turn, reduce interest rates or start next round
quantitative easing. On the other hand, in the event of substantial fiscal push
US Fed would be forced to continue its path of interest rate tightening.
Historically, Global uncertainty
and financial distress have proved to be a boon for US dollar. US dollar did
not lose much of its value even in the 2008 financial crisis, which had its
origin in US soil. Global investors have tendency to rush for US treasury and
US assets in event of financial distress and global uncertainty, which looks
given under Trump administration.
Though, the US dollar index can
correct upto 96.50-97.00 levels, which will mark complete unwinding of initial
trump trade. The US dollar still remains a buy on dips candidate, consolidating
its gains against major currencies.
First Published : 31 Jan 2017.
Source: BloombergDollar Trap
