US equities have enjoyed a ‘‘Trump bump’’ since the 45th president took office. The US dollar hasn’t. The dollar index, which tracks it against a basket of America’s trading partners’ currencies, has slipped by 4% since the beginning of the year, and lost 13% during 2017. It is close to a three-year low. To put the latest decline in context, however, it follows a 27% increase over three years.
So why the reversal? It’s partly momentum. The forex market is especially prone to the herd mentality, and traders are now eagerly clambering onto “the weak-dollar bandwagon”, say Roger Blitz and Philip Stafford in the Financial Times. Many traders were caught out by the initial decline from the early 2017 peak and are now all the more determined to ride the downtrend. US treasury secretary Steven Mnuchin provided another incentive to sell by saying a weak dollar helped the US.
Europe and Japan are doing better
As far as the fundamentals are concerned, a robust economy and the prospect of higher interest rates is normally good news for a currency: the yield on the assets denominated in that currency rise. That would imply a firm greenback, but this factor is being negated by a changing narrative. In the past few months it has become clear that Europe, Japan and emerging markets are looking stronger. As the US recovery took hold first, it is no longer news to the forex market. America “has gone from being the source of the best investment opportunities, to merely being one of many… destinations for capital”, Ryan Boyle of Northern Trust told Barron’s.
Another dollar-negative development is the prospect of a larger fiscal deficit on top of the trade deficit, meaning that America will rely more on foreign financing, says Buttonwood. It was the same story in the 1980s, but then rates rose sharply to get the money into the US. Now they are merely increasing in tiny increments. Then there’s Trump’s “erratic pronouncements”, which may be deterring foreign investment. A Pew survey last year revealed a “dramatic slump” in America’s image.
How the slump could end
One key factor is the extent to which US firms repatriate overseas profits, as the recent tax reform encourages them to do. David Woo of Bank of America Merrill Lynch reckons $300bn will flow back, enough to cover half the current-account deficit. An international crisis would send global investors back into the world’s reserve currency, but the most likely is a return of inflation, prompting faster interest-rate hikes by the US Federal Reserve than the market anticipates. That would also, of course, spell the end of the equity bull market.