Dollar rally runs out of steam

At the start of 2016, virtually everyone was expecting a strong dollar. Virtually everyone was wrong. The dollar index, which tracks the greenback against a basket of major trading partners' currencies, spent most of the year sliding or treading water, only bouncing in mid-November after Donald Trump's election. It hit a 14-year high in early January, prompting widespread forecasts of further gain this year. But history may be repeating itself. In January the dollar index slid by 3.5%, its worst start to the year in over a decade.

The rally "looks to be running out of steam", Pictet Asset Management's Luca Paolini told the FT. The problem is that, "having priced in all the possible good Trump-related news", everyone has finally started to ponder "what might happen if [his] plans fall short or hit the buffers". Trump promised stimulus through deregulation, tax cuts and infrastructure spending. But quite how much of this programme he can get through Congress is hard to gauge. So the boost to growth, and in turn the prospect of higher interest rates, which increase the appeal of US assets, may be less assured than markets first thought. "The dollar's rally hinges strongly on the Federal Reserve moving from one hike a year in 2015 and 2016 to more in 2017," says Philip Wee of DBS Bank in Barron's.

Trump may want a weaker dollar

But the US central bank, wary of upsetting markets and the economy by hiking too early, will err on the side of overheating and inflation. And the latest slip in the annual pace of wage growth gives it scope to sit on its hands. The market forecast of three rate hikes this year may well have to be scaled back.

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Then, of course, there is the Trump administration's protectionist rhetoric, notably the instance that the dollar is "too strong" and thus a danger to US manufacturing. The government could devalue the dollar in an attempt to gain an edge, as it did in 1971 when it moved off the gold standard. It might be all the more inclined to attempt this because Trump's other protectionist measures could push the dollar up for a while at least. Tariffs and export subsidies would boost exports and lower imports, while persuading US firms to move profits back home would also lift demand for greenbacks, says Patrick Hosking in The Times.

If Trump triggers a currency and trade war, the biggest losers would presumably be the currencies of countries with greater exposure to the global economy than the relatively insulated US, says Bank of America Merrill Lynch. But everyone's growth is damaged by a trade war, so it's hard to see the dollar soaring under these circumstances, while shrinking global trade implies less demand for the world's main currency. "The dollar has become a heavier crowd favourite than La La Land", as Tan puts it, but it's hardly unheard of for the crowd to be wrong two years in a row.