The “most crowded trade of 2017” has had a rough go of it this year, recent strength notwithstanding.
Long USD was one of the consensus trades going into the new year as everyone climbed aboard the reflation bandwagon which was being driven by a (bigly) positive correlation between rates, the dollar, and stocks.
Ironically, the dollar leg of the reflation trinity was kicked out from under the Trump trade by none other than Trump himself. The new President, along with trade czar Peter Navarro, have effectively embarked on a campaign of verbal FX market intervention to keep a lid on greenback strength.
This has thrown more than a couple of sellside FX strategists for a loop. We’re in a “structurally strong USD environment,” some will say. “Rate differentials are clearly USD supportive,” others will shout (and there’s some disagreement on that). “It’s not about Trump, it’s real yields driving the dollar lower”, still others will insist.
But to no avail. The Trump juggernaut is all that matters:
Having documented the protestations of Credit Suisse and Goldman and having reviewed SocGen’s contention that real yields are the real culprit for dollar weakness, I though it was worth highlighting Morgan Stanley’s take which, in many ways, is similar to that espoused by the rest of the Street.
Via Morgan Stanley
Trading politics. Despite the US economy showing the strength we had expected and US capex plans turning north, suggesting US capital demand rising, the USD has stayed offered. Markets are trading under the impression that the possible threat of the US imposing import barriers may have led to a revised approach from US trading partners. Indeed, in early January the USD started to turn south when China pushed the RMB higher. Following President Trump’s pre inauguration press conference, the USD accelerated its decline supported by non-USD G-10 bond yields moving rapidly higher. Of course, the better global growth outlook may justify some of this development as markets priced in tighter central banks. However, widening EMU sovereign bond spreads tell us that it may be premature to assume the ECB might bring its tapering forward, suggesting the EUR will remain an under performer.
What is next? For the USD to strengthen again we see the BoJ underlining that it maintains its yield curve-managing approach. Upcoming Rinban operations are in focus. Should these operations remain insufficient to manage JGB volatility on the back end of its curve, then USDJPY is likely to break lower clearing out speculative positioning. The RMB fixing will be important too. Should China’s authorities push the RMB higher against its basket, the USD would come under additional selling pressure. Last but not least, all eyes will be on the Fed, whose latest statement left the impression that it is not in a rush to steer rates higher despite acknowledging that inflation ‘will’ reach 2%, suggesting that it may aim for lower real rates. President Yellen’s testimony on February 14 may turn out to be a substantial risk event.
Caution now warranted. We de-risk our USD long portfolio somewhat as speculative positioning may leave the market vulnerable to additional comments on the currency by the Trump administration. However, our long-term bullish USD outlook based on our assessment of risk-adjusted investment return differentials stays intact