The US dollar had a session to forget on Monday, continuing the slide as markets reprice the likelihood that Donald Trump will be able to meet lofty expectations for spurring on economic growth and inflation following his election victory in November last year.
While the narrow US dollar index, or DXY, is currently teetering just above the lows seen in early February this year, as this chart from the National Australia Bank’s FX strategy team reveals, the broader Dollar Index which captures its movements against a larger number of major currencies has fallen even further, giving back 70% of the post-Trump election rally that started on November 9.
“The air has been leaking from the ‘reflation’ trade since the start of the year,” says the NAB. “The dollar downdraft was then given added impetus from mid-March after the Fed delivered what received wisdom determined was a ‘dovish hike’.”
In more recent times, the dollar downdraft has intensified even further, undermined by the failure of House Republicans to garner enough support for Trump’s proposed healthcare reforms, creating doubt over whether he’ll be able to deliver on other reforms, including tax reform.
“The recent failure to secure Congressional support for health care reforms is helping crystallise these concerns, pushing US bond yields towards the lower end of established ranges and pulling the dollar down in the process,” says the NAB.
While it understands why the dollar has fallen as markets lose faith in the ability of the Trump administration to secure support for substantial tax reform and infrastructure spending, strategists at the NAB are not ready to read the eulogy on the US dollar rally just yet.
“We still believe Fed policy and tax reform can lift the dollar to fresh cycle highs, but near term risk is for a full unwind of post-Trump victory USD gains,” it says.
“The Fed only needs to deliver on its current median dot forecasts in 2017-2019 to take the dollar up through its beginning of year highs, given market pricing that currently has two fewer quarter point hikes than the Fed’s end-2018 median dot forecast and currently assumes a terminal Fed Funds rate nearer 2.25% than the Fed’s 3% ‘longer run’ dot,” it says.
On the fiscal reform front, it is also not ready to write off prospective tax reforms, nothing that Republican appetite, including a slashing of the corporate tax rate, is strong.
“While the fate of a Border Adjustment Tax as a means of partially funding domestic tax cuts is precarious, agreement on a ‘Homeland Investment Act II’ that incentivises US firms to repatriate profits held overseas, is much less contentious,” it says.
“Such tax reforms, that could help fund lower taxes inside America from funds initially pulled from overseas, can support growth, add upside risks to inflation and Fed policy and support the dollar, directly and/or indirectly.”