Foreign Exchange & Commodities (May 2017)

Don't Write Off the U.S Dollar

“It is too early write off the U.S. Dollar. The markets seem too dovish on Fed rate hikes and the extent of its balance sheet normalisation. This presents an opportunity to build up positions in the greenback at low levels”

- Michael Tan, Senior Investment Counsellor, OCBC Bank

  • Political gridlock in Washington has fuelled pessimism over the highly anticipated U.S. tax reform. This, along with the perception that the U.S. economy is weakening, have weighed on the U.S. Dollar.
  • We are in one of those many mini-periods where political noise and risk temporarily trump economic signals. Amid worries over under-delivery of fiscal stimulus in the U.S., French presidential election jitters and tensions in the Korean peninsula, there has been a lack of clear U.S. dollar trend recently. Political noise should not be ignored but, most of the time, will fade sooner than later. Our approach to FX positioning is almost always to focus on the economic fundamentals.
  • It is too early write off the greenback. Tax reform in the U.S. does still seem likely to return may involve some element of fiscal stimulus. The interest rates market is also pricing too little in terms of Fed rate hike and the extent of Fed balance sheet normalisation in our view, particularly if fiscal reforms go ahead. The well-known seasonal adjustment bias in U.S. GDP data has resulted in weak 1Q17 US GDP growth. But we have seen this movie before as growth picks up anew in in the second quarter.
  • Political events have also taken centre-stage in the U.K. with Prime Minister May calling for early elections on 8 June. The initial bullish reaction of the Pound to an early U.K. election seems overdone. It is not clear that early elections will lead to softer Brexit stance or make the EU give the U.K. a better Brexit deal. We wouldn’t chase Pound rally.
  • In Europe, the eurozone’s improving economic fundamentals, strengthens our conviction that the downtrend in Euro is gradually turning as European Central Bank comes under pressure to exit from extremely accommodative stance of monetary policy.
  • In commodity markets, gold remains a valid asset to hold against political and macro uncertainties. Jitters over geopolitical escalation in North Korea, worries over flagging U.S. economic growth and rich U.S. stock market valuation should keep gold prices supported in the near-term. However medium term, real U.S. interest rates could firm back up, which once again could be gold negative.
  • In oil markets, OPEC’s efforts appear to have put a floor under prices, but they face the headwind from rising U.S. output, which is adding to already-high inventory levels. The U.S. rig count has more than doubled from the lows of April 2016 as enough producers find it profitable to drill at current prices, and output is already recovering.
  • Short-term volatility is inevitable, but oil prices are constrained on the upside by the threat of output rising as more of the marginal producers become profitable. Meanwhile prices are limited on the downside by OPEC controls on excess supply and inefficient producers being squeezed out of the market. It looks as though the longer-term equilibrium price where supply and demand is in balance is perhaps in the US$50-60 per barrel range, which implies prices should be relatively stable around current levels.