Foreign Exchange & Commodities (February 2017)

U.S. Dollar Rally Stalling?

“The greenback is at a new cycle high. It is already rich relative to fair value and has priced in a lot of fiscal optimism but not enough trade protectionism risk in our view.”

- Michael Tan, Senior Investment Counsellor, OCBC Bank

  • The greenback’s rally has been hampered as President Trump takes office. The U.S. dollar has corrected amid concerns of a possible delay on the delivery of growth-positive fiscal measures. Growing signs that reflation is a global, not just an American-only, phenomenon also challenges the idea that U.S. dollar should be exceptionally stronger.
  • Recent comments by Trump that the U.S. dollar is “too strong”, has also undermined the currency. Expectations that Trump will tone down the trade protectionist rhetoric that got him elected appears false. Global risk sentiment, which is approaching “complacency” territory, could sour if trade tension escalates as the U.S. threatens import tariffs. Emerging market currencies are vulnerable to higher risk aversion and are likely to underperform reserve assets such as the Gold, the Euro and Japanese Yen.
  • Given that the medium-term trend of a weaker Renminbi is still intact and the non-negligible risk of U.S. trade protectionist policies targeting China, we maintain our bearish view on trade-exposed Asian currencies. The clear risk to our view of weaker Asian currencies is the Chinese central bank attempting to hold the Renminbi stable for longer than we forecast to reduce risk of trade friction with the United States.
  • The Pound rebounded after U.K. Prime Minister Theresa May confirmed intentions to leave the EU single market. However, we remain worried that the heavy political calendar in Europe this year will lead the EU towards a tough negotiating position and the market could start pricing “hard Brexit” again.
  • We continue to see Gold as a valid asset to hold as a diversifier and hedge against concerns that a potential escalation of trade tension between the U.S. and China could threaten the global recovery. Safe haven buying has been a feature of the Gold market since the start of 2017, and we expect this to continue as Trump moves quickly to initiate his campaign policies. An expected decline in U.S. real interest rates and the possibility of a weaker U.S. dollar could add to Gold's appeal over the next few months.
  • OPEC seems to be having success in reducing output, which is allowing prices to push above the US$50 per barrel level. The main impact of the OPEC deal is to limit downside risk, as it reduces the threat of extreme over-supply. Upside remains limited by alternative (higher cost) supply becoming more viable as prices rise. This is already evident in the U.S., where the rig count is up 70 per cent from the lows of May 2016.