Foreign Exchange & Commodities (December 2016/January 2017)

Making the U.S. Dollar Great Again?

“Trade-exposed Asian currencies which have been the greatest beneficiaries of globalisation stand to lose most from an escalation of trade tension between China and the United States.”

- Michael Tan, Senior Investment Counsellor, OCBC Bank

  • The possibility of stronger economic growth and higher interest rates in the United States should augur well for the U.S. Dollar, and there are good reasons to be positive about the currency. However there is insufficient information so far on the Trump’s administration’s priorities and the magnitude of its intended policies and until we get more clarity it’s hard to say with a great deal of conviction that the U.S. Dollar could surge significantly against other major currencies like the Yen and the Euro.
  • Two other considerations complicate the path of the U.S. Dollar against reserve currencies. First is the lurking fear that if trade disruption becomes a first-order issue, this would help the Euro and Yen while undermining Asian currencies. Second, if the drag on U.S. growth from the stronger greenback and higher yields manifests before the boost from fiscal policy, then we may see additional market volatility as positioning and investor expectations get revised. The U.S. Dollar could then struggle as the markets reassess “Trumponomics”.
  • Trade-exposed Asian currencies stand to lose most from an escalation of trade tension between China and the United States. So far China has not reacted to the U.S. election. The Chinese currency has been weakening against the U.S. Dollar but the currency has actually been stable-to-slightly stronger against a basket. Whether the Chinese currency will continue to remain stable against its basket is a risk that we will have to remain vigilant over, as an acceleration of its weakness would have an adverse spillover effect on other Asian currencies.
  • Low oil prices in 2016 had put a strain on a range of oil producing countries. This lends some credibility to the OPEC deal to cut output, even though enforcement will be a problem, as usual. OPEC still accounts for over one-third of global production. Unfortunately for OPEC, shale has changed the dynamics of oil production as supply can quickly respond to a rise in prices. The U.S. rig count is already up nearly 50 per cent from the lows of May 2016 as producers respond to the prospect of higher profitability. This will limit the upside to prices.
  • We are not long-term gold bulls but there are enough uncertainties ahead – from politics to potential policy impact on growth/inflation – to support gold prices going into early 2017. However, the Trump victory in the U.S. elections has repriced the U.S. Dollar and interest rate expectations higher, both of which are headwinds for gold prices. Consequently, we have lowered our gold price forecasts. However, gold should still offer protection to portfolios in risk-averse periods, especially after its recent sharp fall; gold prices should rise fast when risky assets run into trouble.