Foreign Exchange & Commodities (April 2017)

U.S. Dollar Down but Not Out

“The U.S. dollar setback is likely to be incremental rather than acute from here, as the greenback is set to keep benefitting from the backdrop of a strong U.S. economy and further Fed tightening.”

- Michael Tan, Senior Investment Counsellor, OCBC Bank

  • Markets are worried that Trump will keep struggling to get any of his agenda through Congress this year following his failure to pass this healthcare bill. This has dampened expectation about tax reforms and large-scale infrastructure programs. We think the de-pricing of the Trumpflation trade is already at a mature stage and continue to expect the U.S. dollar to be “not great, not bad but just good”.
  • Political risks in Europe seem to be abating and the PMI indicators surprised strongly to the upside, keeping European reflation in focus. If the French election tail risk is avoided, strengthening economic momentum suggests further upside potential for the Euro.
  • In the month that follows the Article 50 trigger, the EU will publish the “Brexit directives” that will set the tone for the EU negotiation. Markets will scrutinise the details to assess the probability that the trade negotiations could happen alongside the divorce deal (citizens’ rights, UK’s Brexit bill). It is likely that the EU will seek to limit initial talks to the latter. The market is pricing increasing probability of a Bank of England hike, which seems premature. With valuations for the currency extremely cheap and speculative positioning still short, there is a risk that Pound rallies become more frequent. But we still struggle to justify turning bullish on the Pound at above US$1.20.
  • Although political risk in Europe has receded following the first French presidential debate, hopes of a gradual Fed rate hike and worries over Trump policy delays have benefitted gold price. Gold's reaction thus far should help assert its role as a portfolio diversifier and this could gain further traction should the reflationary ‘Trump Trade’ stall further.
  • In March, concern over inventories and the supply discipline of OPEC producers sent oil prices lower, with speculative short positions increasing sharply. This is the type of moderate short-term volatility that we can expect as 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.