One of the surprises for markets this year has been the weakness of the dollar. Last year, investors built up large speculative positions expecting the dollar to go better. The US was beginning to increase its interest rates and would in due course reduce its stockpile of government bonds held by the Fed. As more yield became available on US paper, so more money would move into the US from the low or no yield markets of Japan and the Euro area. By the end of last year the dollar was indeed riding high hitting 129 on the trade weighted index. It took 125 yen to buy a dollar, and 96 eurocents at the dollar’s strongest.
This year, the big speculative positions betting on a stronger dollar have unwound. Some disappointment set in for dollar bulls, as the Trump administration struggles to get reflationary change through the Congress. The Fed has turned out be less hawkish as US inflation subsides and wage increases stay low. Today it takes 112 yen to buy a dollar, and 87 eurocents. The dollar has fallen back to around 120 on the trade weighted, a devaluation of 7% from the highs.
The President has asked them to simply repeal Obamacare
The immediate background to dollar weakness is the Republican failure to get their healthcare reform bill through the Senate. After a titanic battle, Speaker Ryan piloted a compromise reform bill through the House of Representatives. In the Senate, where the Republicans have a majority of just four over the Democrats, the Republican leader Mitch McConnell was assailed from both sides. Moderate Republicans opposed the losses of healthcare for poorer citizens, whilst hawkish Senators complained that the compromise did not repeal enough of the Affordable Care Act of Mr Obama. The President has asked them to simply repeal Obamacare instead of attempting a replacement, but this too faces a challenge from the moderates who will dislike that idea more than the Bill they are refusing to support.
The weak dollar is not mainly about the Republican healthcare disagreements. Inflation has fallen away sharply as the oil price and other commodities stabilise. The Fed is in no hurry to push up rates, and income growth remains sluggish. The market worry following healthcare is the tax cuts too may be delayed further or may fall owing to tensions within the governing party. Republicans who want tax cuts include politicians who wish to curtail the deficit. This will mean voting for spending cuts that moderates will be reluctant to accept. There are difficulties in constructing a budget which meets national deficit requirements under the accounting conventions adopted by the Office of the Budget. The Trump/Ryan belief that their tax cuts will generate a lot more revenue will not be fully reflected in the official scoring of the changes. The absence of an agreed healthcare Bill means an absence of healthcare savings which were going to help pay for the tax cuts.
All these uncertainties reinforce our view that the market is not assuming a Trump reflation any time soon. Tax cuts would be a bonus for the US market, if they do find a way to unite their party in both houses of Congress. The dollar has now fallen quite a lot from the end of year highs in 2016 which will offer a modest stimulus to the US and help the Trump programme of more being made in America. In due course, markets may resume their view that the US will offer a better interest return than other major currencies, making them more inclined to buy the dollar again.
The above article was first published by Charles Stanley on 21st July 2017