USD: Weakness in store? - Rabobank

The inference of Trump’s ‘America First’ policy is that the US administration would favour a weak USD and comments from US Treasury Mnuchin at Davos this week appear to have removed any lingering doubt, according to Jane Foley, Senior FX Strategist at Rabobank.

Key Quotes

“Not only did Mnuchin yesterday remark that a weaker USD is good for trade but this morning he refused an opportunity for backtracking by remarking that his comment on the USD was quite clear. Despite his protests that he did not want to enter into a trade war, it cannot be denied that a weaker currency is a good weapon for a country intent on boosting its exports.”

“Trump’s actions in pulling the US out of the TPP, renegotiating NAFTA and this week slapping large tariffs on imported washing machines and solar panel have clear protectionist conations. The timing of Mnuchin’s comment on the dollar, just a day ahead of Trump’s keenly awaited speech at Davos, is thus bound to raise concerns that the US President could be in the brink of stepping up pressure on the trading partners of the US. Protectionism can take many forms and involve a complex set of tariff and non-tariff restrictions on imports.  In terms of attempting to boost exports, the US is not the only country ever to attempt to manipulate its currency to support the domestic economy.”

“In recent years, the market was awash with the theme of currency wars. This was facilitated by the low inflationary environment. Generally speaking a strong currency is useful in fighting back rising prices, the US Treasury’s burial of its old strong USD policy has been allowed in the first instance because of the lack of inflationary pressure.  The theme of currency wars faded in early 2016 after a G20 summit in which major central banks focussed on currency manipulation as one of the causes of global economic instability and urged all countries to refrain from becoming involved.  Since then the recovery in global growth and a less dovish policy stance from many central banks has reduced the relevance of currency wars. That said, the low inflationary environment persists and there are still plenty of signs that several central banks continue to favour a soft currency.”

“The ECB will also be watching the exchange rate and this year’s surge in the value of EUR/USD could have some bearing in the tone taken by ECB President Draghi at this afternoon’s post policy meeting press conference.  Certainly, Mnuchins' comment regarding the USD have raised the odds that Draghi could fight back today with some cleverly worded EUR dampening rhetoric.”

“It is our suspicion that the market may have got ahead of itself with respect to expectations regarding ECB policy.  We believe that March rather than today is a more likely date for the ECB to outline changes in its forward guidance and the recent sharp gains in the value of the EUR strengthen this view.  We also do not expect the ECB to abruptly halt asset purchases in October nor do we expect an ECB rate hike before 2019.  Draghi managed to sound dovish in December, pushing down the value of the EUR and there is clear risk that he will do so again today.”

“If Draghi takes a dovish line today, EUR/USD could suffer a setback. However, this may not be sufficient to shake off the weight of USD bears particularly in light of Mnuchin’s comments.  It appears that we will be forced to reassess our 12 mth EUR/USD forecast of 1.24.  However, we will do this in the wake of today’s ECB meeting and in the shadow of Trump’s Davos address.”