For now, we can all point to the “patient” Fed when explaining the majority of the dollar’s recent declines and I would argue that’s the only interpretation that’s tenable, where “tenable” means unequivocally risk+.
When you start describing the dollar’s (welcome) pullback in terms of jitters around the U.S. government shutdown and signs that the domestic economy is about to fall off a cliff (if you assume that payrolls are simply lagging other indicators), then it’s less clear that dollar weakness is a good thing for risk assets. Sure, it wouldn’t be the worst thing for the U.S. economy to “catch down” to the rest of the world’s reality, but “catch down” is something different from “crash down” – the former implies a glide path, the latter a hard landing.
Whatever the case, the Bloomberg gauge is on track for its worst weekly loss in 11 months and this is four straight weeks of declines.
Clearly, that’s predicated on the procession of dovish Fed speakers that were rolled out this week to drive home the “patient” narrative, with Powell and Clarida rounding things out on Thursday and the December minutes serving to retroactively take some of the sting out of Powell’s post-meeting presser as markets perhaps reprice to reflect what he “meant” to say/convey.
The balance sheet issue is still a sticky one, but Fed officials have clearly convinced the market that they get the message about the inherent peril of more hikes.
Dollar weakness combined with what are supposed to count as “convincing” signs of “real” progress on trade (with the latest headline being that Chinese VP Liu He will visit the U.S. on January 30-31) served to catalyze the best week for the onshore yuan going back to 2005.
That’s a double-edged sword for China. On one hand, it’s a negative for the export-driven economy which is already sputtering. On the other hand, it helps alleviate capital flight concerns and gives the PBoC more scope to ease. But even that has a kind of question-begging character to it – that is, yuan strength predicated on a less aggressive Fed and thereby less policy divergence, gives Beijing scope to ease which would negate the Fed’s dovish pivot, driving the policy divergence wider again, begetting yuan weakness and stoking capital flight concerns.
For the time being, it is what it is and the rapidity and sheer scope of the move has almost surely caught some folks wrong-footed which sets the stage for a squeeze in the event the trade news stays positive and/or the dollar stays on the back foot. But don’t believe anyone’s wholesale reappraisal of the prospects for the yuan. The economy is still decelerating, the likelihood of a lasting trade deal is small (especially considering the possibility that Trump only wants a deal because it would boost U.S. stocks – if they rise of their own accord, he might just go back to being hopelessly recalcitrant) and further easing from the PBoC will put the pressure back on the currency.
Capital flight, though, seems unlikely to materialize in the same way it did in 2015. After all, where is that capital going to flee to? Not the Vancouver housing market anymore because after all, they’re arresting wealthy Chinese up there now. London? Not likely. Brexit is a train wreck. The U.S.? America is hot a mess right now.
Anyway, as long as dollar weakness is couched in terms of the Fed’s “dovish evolution”, that’s going to help reignite the reflation narrative even against data that argues to the contrary (did you see Chinese PPI and CPI this week?) Crude is obviously surging and that’s helped put the brakes on the breakeven bleed.
And, the flip side of the weaker dollar and resurgent risk sentiment is a loosening of conditions at the margins, a welcome reprieve after the last three months.