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Mecardo Blog

US dollar in the sin bin, but for how long?

Posted by Mecardo on 4 February 2018

Continuing robust US data has become more of an expectation than a surprise over the last few months as FED Chair Janet Yellen in her final meeting highlighted the Board’s growing confidence in the US economy.

However, the better than expected numbers, plus the expectation of three interest rate hikes in 2018 by the FED reserve, and the eventual passing of U.S tax reforms has left the FX market confused by the lacklustre performance of the USD.

Why has there been a decline in the US dollar?

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The US dollar hasn't reacted to the passing of US tax reform. It was argued by Trump himself that the repatriation of US company earnings could see billions of dollars flow in from US companies abroad. The tax cuts at this point haven't had any meaningful impact on the US dollar, as it now appears that as much as 2.6 trillion of funds abroad may in fact already be in dollar-denominated assets.

In recent times, we have even seen conflicting rhetoric from Treasury Secretary Steven Mnuchin and President Trump with respect to the US dollar. The Treasury said a weaker dollar would be good for trade raising the ire of ECB boss Mario Draghi. Speculation mounted that the administration was abandoning the strong-dollar policy that’s been in place for decades. However, Trump later called for the US dollar to strengthen in line with the US economy but followed up with very little in his recent State of the Union Address.

The decline can also be attributed to other currencies strength. 

The U.S dollar declined by 12% against the Euro for the year (figure 1) and while the ECB has trailed behind the FED in ending its quantitative easing, strong economic data and positive company earnings has seen the Euro strengthen against the greenback. 

Likewise, the AUD has had a huge 2 months (figure 2) fuelled by a world growth story and buoyant commodity prices, especially copper and iron ore, together with continued good economic numbers out of China. China has cut levels of pollution by favouring higher levels of iron ore from Australia.

One should also not underestimate the impact of large M&A deals on the Australian dollar. Late last year Unibail-Rodamco, a European owner of shopping malls, announced the agreement to buy Westfield for A$32.7bn, 35% of which will be paid in cash.  While the deal won’t likely close until mid-2018, hedging of at least some of the proceeds back to AUD has probably occurred.  At about the same time, Zurich Life announced that they would buy ANZ’s Australian life insurance business for A$2.85bn.

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Where to for the AUD?

Forex Sport believes that the underpinnings of the supported Australian dollar could be short lived. Australian growth and inflation are likely to remain subdued and interest rates low, which will see the interest rate differential between Australia and the US widen.

Indeed, the very strong US employment data released over the weekend has got the ball rolling with a couple of cents shaved off the Aussie dollar and markets are now starting to notice the potential of a growing interest rate differential between the two nations.

Commodity prices could also be under pressure as monetary conditions in China begin to tighten. China and their economic conditions tend to lag and the full impact of tighter monetary conditions probably hasn’t been felt.

A guest blog by Dion Ciavola, CEO Forex Sport

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Topics: currency