Strength of the Dollar: Will the Dollar become really Strong

Strength of the Dollar: Will the Dollar become really Strong 

The most anticipated trade of 2016, Trump or No Trump is over and Wall Street and other markets have moved on to the second most anticipated trade on how strong would the Dollar become. With the pre-election mood of made in America for America by Americans, the Dollar looks to become very strong but how strong would it really become and how strong would the Trump administration like it to become is the question that would be guide the world markets in 2017. This would be the Trump trade 2.0.

The first trade was about a sudden swing away from positioning for deflation and an economy dominated by monetary policy, in favor of readying for inflation and an active fiscal policy. Having grown slightly excessive, that Trump trade has been corrected somewhat and a second Trump trade starts.

This trade will last and dominate a major portion of the way, markets trade in 2017.  I suspect, until markets have learnt how to interact with a novel means of policy communication. It will involve increasing volatility, and the critical variable will be the dollar.

The fluctuations so far have given the clearest taste of what lies in store. Donald Trump, provided the fuel in an interview recently where he described the Dollar as “Too Strong “.  This was obviously dollar negative.

Also, more importantly he gave an idea on the border tax,  the idea that taxes should be based on cash flow, rather than income or profit, and be applied on a destination basis. This would mean products exported outside the US would not be subject to US tax, while imports would be taxed wherever they were produced. This is a radical notion, supported by many Republicans in Congress, and very much in line with the wishes of Mr Trump’s core electoral support.

After banks and investors across Wall Street had published copious research on the possibly profound effects of a border tax on both equity and foreign exchange markets. The president make a few statements that a border tax would be complicated and he himself would love it.

Most Analyst on Wall Street and in other markets are of the consensus that border taxes are complicated. Any version would create winners and losers among equities, dealing a potentially critical blow to businesses whose model revolves around imports, such as retailers, whose shares have been under pressure so far this year. It would also have a direct impact on the dollar.

Market Pandits at Wall street feel that dollar would go up one-for-one with a border tax, which was “short-term right, long-term very wrong. The rise in the dollar would counteract the higher cost of imports.

The border tax would strengthen the dollar, at least until it stimulated US businesses to substitute imports with goods built at home. While markets have moved to discount some of the risk, positioning even before it actually happened.

                                                        

 There was enough interest on border tax for the president’s comment to push down hard on the dollar, whose trade-weighted index is down 3.44 per cent from its high two weeks ago, and back to a level it first reached a week after the election.

Antipathy to a strong dollar would make it harder to raise rates and the federal funds futures market has pegged back the odds on three rises this year, as projected by the Federal Reserve, to where they were before the Fed’s statement last month. The yield curve, expressed as the gap between 10-year and two-year Treasury yields, has tightened and is flatter than it was at the beginning of 2016. These are corrections to the first Trump trade.

Meanwhile financial stocks, despite earnings figures solidly ahead of expectations so far, have suffered in line with the shifting picture on rates and the dollar.  The value stocks have had a rotten start to the year, for a similar reason, while dividend earners have recovered slightly.

Progress will depend on what gets passed in Washington — and investors will have to put up with plentiful confusion and conflicting starts. Expect rising volatility and reduced correlation between stocks as traders react to Mr Trump’s specific comments as they arise. Investors will have to put up with plentiful confusion and false starts.

_ Farzan Ghadially