Where next for the US dollar?
Down, versus the euro.
The initial reaction of the US dollar to Donald Trump's policy plans has been a rally, as markets expected more hurried Fed hiking. The trade-weighted dollar has increased 1.9% since markets closed on 8 November. Investors appear to be expecting a switch from monetary to fiscal policy, with Republican tax cuts forcing the Fed to hike rates more aggressively. The USD has rallied on expectations of a re-pricing of US short interest rates.
There is a historical precedent, say the dollar bulls: fiscal stimulus under President Reagan led to a 45% surge in the US dollar index between 1981 and 1985 (see graph in the picture).
We disagree with this hypothesis, and this month we introduced a preference for the euro versus the US dollar in our global tactical asset allocation.
First, we believe the Fed is unlikely to hike aggressively while uncertainty lingers over how future US trade and immigration policies could impact potential GDP growth. The Fed’s gradualism should result in lower US real yields, and weigh against the US currency.
Second, the fundamentals and policy outlook for the Eurozone all imply a stronger single currency next year. Economic momentum is solid, and the waning effects of a weak oil price should lead inflation to accelerate from the fourth quarter 2016. The European Central Bank (ECB) may therefore begin talking about tapering its bond buying next year. Coupled with a persistent current account surplus, less forceful easing from the ECB can allow the euro to make gains against USD.
An unexpected result from any European vote has the short-term potential to delay a euro strengthening or provoke currency turbulence. But favorable fundamentals support a stronger EUR over our tactical six-month investment horizon.
Last, the starting point for the US dollar today is one of overvaluation, in contrast to the 1980s experience. Prior to the start of Reaganomics, the US dollar largely held its value (–0.6%) over the previous 12 quarters. In contrast, today the USD has appreciated by 19% over a comparable timeframe. We estimate the long-term purchasing power parity of EURUSD to be 1.25, some 17% above today’s spot level.
Read my full monthly investment letter on ubs.com/cio (may not be accessible in all regions). This month I address some of the critical questions Donald Trump’s victory raises for investors:
- Will the election effectively mark an end to the multi-decade bond market rally?
- Will the president-elect stop the emerging markets (EM) revival in its tracks?
- How did the election outcome affect our current tactical asset allocation?
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8 年The key here is the Fed meeting and US jobs report. If the Fed proceeds with the much anticipated rate hike, traders will take profits. If there is a material slowdown in the jobs report and the Fed once more delays a rate hike (doubt it), then the USD will decline even faster than a normal profit taking after an anticipated rate hike. If the USD keeps climbing relative to other currencies, which can happen, then it will wreak havoc in Asia and possibly cause another crisis there. Too soon to worry about that now.