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FX Monthly Outlook: Dollar Gains Fueled By Tax Reform, Diverging Monetary Policies & Shaky Euro Politics

 |  November 05, 2017

The dollar put in its best monthly performance of the year in October1, with four bullish themes: 

  1. Optimism for tax reform
  2. Diverging central bank monetary policies
  3. Shaky European politics 
  4. Traders caught with large short dollar positions 

These themes should remain relevant for the remainder of the year –– hence, my short-term dollar bullish outlook.

October is historically a month of dramatic swings in the financial markets. But this year, they behaved rather nicely with low volatility characterizing most major markets –– even in the midst of several potentially disruptive events both here and abroad.

Trump’s decision to choose Jerome H. Powell as the new Fed chairperson did not cause distress –– nor did the extraordinary election results in Japan, Austria and the Czech Republic. The ongoing Spain / Catalonia independence dispute is simply being watched closely.

What’s in Play

U.S. tax reform. A ‘tax plan rally’ may already be materializing –– with small- and mid-cap stocks moving higher, the dollar gaining ground and bond yields edging higher.2 But, I’m not sure if I trust it yet.

Brexit negotiations will be at an impasse until agreement is reached on the bill the United Kingdom must pay to leave the EU. A key meeting scheduled in December may speed up the process. Traders are light on GBP positions.

German coalition. Five weeks after Germany’s election, the political parties involved in the coalition talks have yet to agree on key policy issues. The outcome may well determine Germany’s stance on key EU issues and whether Chancellor Angela Merkel remains a dominant figure in the European Union.

NAFTA talks. The fifth round of talks begins on November 17.3 Mounting concern that talks may collapse have pushed both the Mexican peso and Canadian dollar to multi-month lows. Representatives from both Mexico and Canada are critical of what they call overly protectionist U.S. demands. No surprise there. 

Global equities. Strong earnings and cheap financing continue to fuel global equity markets. Geopolitical threats are not unnerving equity investors –– yet –– so the eight-and a half-year bull market remains intact. If and when a significant sell-off does occur, I expect an initial dollar rally. However, when the dust settles, I anticipate a significant move into Emerging Market and Asian stocks, bonds and currencies.

What’s Next

October U.S. Jobs Report. The impact of the two big hurricanes was felt in September, so October’s job recovery should be sharp. Bloomberg’s survey is for a 310K increase in non-farm payrolls. But given September’s loss of 33K jobs and an average of 171K a month this year, we could see a much higher print. Average wage earnings will be closely watched –– the survey says 0.2 percent MoM.4

FX traders may sell the EUR. It has been a tough year for currency speculators. They were short euros in the first half of the year when it was strengthening, then they reversed and are now long euros as it weakens. I expect a gradual unwinding of those long positions going into year-end, which should cap euro strength. 

The U.S. budget deficit is huge and growing. Trump’s tax proposals have created great enthusiasm for the dollar, but most economists agree that his plan will widen the budget deficit –– an outcome that’s hardly bullish for the dollar over the long term.

What Happened

Trump announced the new Fed Chair (Nov 2). Trump nominated Jerome H. Powell as the new Fed Chairman. Powell brings competency and stability, but is more dovish than the other candidates. So the dollar declined slightly and Treasury yields drifted lower. 

The Bank of England (BOE) raised its benchmark interest rate for the first time in 10 years (Nov 2).4 The BOE meant for this to be a ‘dovish’ rate hike –– simply taking back the rate cut delivered after last year’s BREXIT referendum. It’s not the start of a tightening cycle, so the pound may head back down to $1.30 or lower. 

Catalonia’s secession was foiled (Oct 28). Spain took direct control of Catalonia after dismissing their president and Cabinet and dissolving its Parliament following the Catalonia legislature vote to declare independence. Traders of Spanish bonds, equities and the euro have not overreacted.

ECB’s dovish decision avoids taper tantrum (Oct 26). The European Central Bank surprised the market when it decided to extend its bond buying until at least next September at €30bn a month after its current €60bn a month ends in December. Market impact saw the euro drop by 2 percent.5

Bank of Canada was more dovish than expected (Oct 25). Traders were gearing up for another rate hike, but the BOC disappointed and made clear it will move cautiously going forward. The Canadian dollar remains on its back foot.

China’s Communist Party Congress closed (Oct 24). Xi Jinping –– smart, tough and calculating –– consolidated power as president of China. He is confident he can combine tight political control with continued rapid economic growth and technological innovation. The October 14 cover story of The Economist featured an image of President Xi with the headline, “The world’s most powerful man.”  

Japan re-elected Shinzo Abe as prime minister (Oct 22). A decisive victory by Abe was unexpected. He can now cement his position as one of the most important prime ministers in post-war Japan –– which gives him the mandate to continue his economic program of fiscal stimulus and large-scale monetary easing. A weaker yen is certainly desired by the government to support Japanese exporters, but FX traders have yet to accommodate. The yen has moved little since the election.

 Nov 2017 Spot Returns Chart FX monthly

 

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Sources: 1, 2: Bloomberg. 3, 4, 5: Financial Times

This article is intended for US audiences only.

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The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction. 

Foreign exchange transactions can be highly risky, and losses may occur in short periods of time if there is an adverse movement of exchange rates. Exchange rates can be highly volatile and are impacted by numerous economic, political and social factors, as well as supply and demand and governmental intervention, control and adjustments. Investments in financial instruments carry significant risk, including the possible loss of the principal amount invested. Before entering any foreign exchange transaction, you should obtain advice from your own tax, financial, legal and other advisors, and only make investment decisions on the basis of your own objectives, experience and resources.


 

 

 

 


About the Author

Scott Petruska is a senior advisor for Silicon Valley Banks’ global financial services group, and is based in Boston, MA. He advises clients on currency and interest rate hedging strategies and helps them with other aspects of global banking. He regularly writes blogs on topics covering the global financial markets, conducts client seminars and webinars, and speaks at regional financial conferences.

Petruska has over 30 years experience in the currency and interest rate markets, and has lived and worked in Boston, Chicago, New York City, Singapore and Tokyo. Prior to joining SVB in 2009, he worked at several large international financial institutions, including National Westminster Bank, Irving Trust, Bank of New York, State Street Bank and Commerce Bank. He has been an institutional trader, product developer, analyst, salesperson and advisor.

Petruska has been awarded several professional designations, including the CFA (Chartered Financial Analyst), FRM (Financial Risk Manager) and CMT (Certified Market Technician). He earned his undergraduate degree in Finance & Banking from the University of Wisconsin.

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