The U.S. dollar staged a major rebound in the fall of 2016. Boosted further by Donald Trump’s election in November, it rose 4 percent between Election Day and December 30, 2016, before losing momentum. The Trade Weighted U.S. Dollar Major Currencies Index looks as if it will close out March 2017 having given back much of its post-election gains.
Whether the U.S. dollar is truly strong or merely benefiting from weakness elsewhere is somewhat in the eye of the beholder. Over the course of 2016, Brexit damaged the British pound and the Italian referendum should have hit the euro, but the reaction was more the opposite. The Chinese yuan is weak as a matter of Chinese policy. The only major currency that appeared to weaken relative to the U.S. dollar is the Japanese yen, and now even that weakness has reversed.
Given adverse events elsewhere in the world and the prospect of a pro-growth U.S. presidency, one might have expected more than a small bounce in the dollar. In actual fact, the dollar is valued not so much for its safe-haven value, but because there are few alternative advanced economy currencies with positive interest rates.
Our view continues to be that the dollar has established its long-term peak and will weaken over the course of 2017. We had thought that dollar highs in early 2016 constituted that peak, but the events that have unfolded since midyear were almost all U.S. dollar-positive.
Once the Fed raised the Fed funds rate, the market question was “what’s next?” Even should the Fed add to its planned interest rate increases in 2017—which does not now appear likely—we expect these increases to be gradual.
The Fed has shown no appetite for really tightening policy. As Vice Chairman Stanley Fischer has stated, interest rates will normalize at levels lower than in past cycles, in which case we expect that U.S. dollar markets will disappoint.
The foundation of our currency analytics is trend and standard deviation analysis. This approach helps us determine if the currency in question, in this case the U.S. dollar, is strong or weak relative to its trend and if it is trading at unusually high or low levels.
The trend in the relative dollar value has declined since the early 1980s. It has also declined since 1999, which we use as a starting point because it marks the introduction of the euro. The surge in the dollar during the Reagan years was exceptional because inflation-adjusted interest rates were as high as 10 percent. Since the 1980s, real interest rates have been much less of a factor because they have been relatively low.
This approach calibrates the extent of U.S. dollar strength, which is trading two standard deviations above the mean. In probability terms, we should expect the dollar at current levels only about 5 percent of the time (Chart 1).
These conclusions are further supported by the long-term cyclical analysis provided by our adviser, Peter Goodburn, founding partner, WaveTrack International, cited in our Gradually Gathering Momentum report from 2015. WaveTrack charts long cycles for commodities, stock markets, currencies and individual stocks, among other financial instruments. Goodburn’s long-term dollar analysis shows that dollar cycles follow a roughly predictable 15- to 16-year cycle from peak to peak and trough to trough (Chart 2).
We believe that these statistical analyses, which we use as a cross-check on our fundamental analysis, are supported by growing inflationary policies and conditions in the United States and overly cautious Federal Reserve policy. It is worth noting that even a more aggressive Fed will not help the dollar because higher short-term rates will blunt growth expectations, which help support the dollar today.
Login in below to access content exclusive to clients of The GailFosler Group.
Not a client yet? For more information on the benefits of becoming a client, please contact us.