The US dollar has been on a tear since the US election, notching up some impressive gains in a relatively short period of time.
The chart below from HSBC shows the US dollar’s gains against other major currencies since November 8.
The allure of a fiscally-charged stimulus splurge from incoming US president Donald Trump has clearly appealed to many investors, bolstering the view that his policies will lead to faster US economic growth, a pickup in inflation and higher US interest rates.
It’s proved to be a potent mix.
However, if you think that the US dollar rally will continue unabated over the entirety of 2017, think again, says HSBC’s FX strategy team.
In a note released earlier this week, it suggested that the FX market is currently dominated by the belief in “Trump-flation” story, something that they believe has provided significant support for the USD since the US election.
While the bank expects that trend to continue in the first half of the year, fuelled by what it describes as “euphoria, optimism and hope”, it doesn’t see it as a sustained force.
HSBC looks to recent history for inspiration.
“We saw with the JPY in 2012 and 2013 that the market’s belief can remain unfaltering even when results are mixed. Hence, we would not stand in the way of the USD rally, even if we are ultimately not that convinced by the reflation story,” strategists at the bank wrote.
“However, by mid-year the euphoria of a Trump presidency will start to fade.
“We believe too much will be priced in to the currency market in terms of a successful reflation trade. The USD rally will reverse as belief in Trump-flation turns to realisation that the scale of policy overhaul is relatively modest (“Trump-lite”), and that the results are underwhelming as a consequence (“Trump-failure”).
As a result, the bank says that it expects a retracement in the US dollar from mid-year to the end of the year — a “buy the rumour, sell the fact” outcome, to borrow some markets vernacular.
“We expect the USD to rally on average by around 5% by the middle of the year,” it says.
“However, as belief in Trump-flation starts to fade, we see the USD reversing much of this rally, falling by around 4% from mid-year to end-2017.
“EUR-USD will rally back to 1.10, USD-JPY will drop back to 115 and EM FX will recover to finish the year only a little softer versus the USD.”
HSBC’s updated G10 FX forecasts are found below: