USD refuses to drop despite pending rate cut, deficit, and Trump bashing

Tom Cleveland

The U.S. Dollar index continues to maintain its value in the 97.0 corridor, even when it has been roundly attacked by policymakers. Deficit levels are at their highest, roughly $1 trillion, and show no signs of decline, and the futures market has already priced in between two and three 25bp interest rate cuts by the Fed over the next twelve months. It appears, however, that the Dollar’s strength is more a result of weakness everywhere else. Per one pundit: “It looks as if the value of the US dollar will remain strong and may even grow stronger as other nations attempt to improve their economic condition.”

USD Index Chart

Yes, the USD index did fall before the month of July commenced, a recognition that the Fed was showing signs of caving in to political pressure from the Trump administration. It bounced off 95.4, however, and returned to 97+ territory, perhaps, due to an agreement being reached to raise the debt ceiling before the government ran out of money. The deal should provide for an appropriate level of spending, without making another debt ceiling renewal a campaign issue in 2020.

European currencies comprise 77% of the basket of currencies that constitute the USD index, and the Euro and Pound Sterling make up 69% of that overall figure, while the Swiss Franc and Swedish Krona contribute the remaining 8%. It is no wonder then that market movements in the index are heavily influenced by what is transpiring in the EU and UK at the moment.

Mario Draghi, who will soon be departing from his chairman position at the ECB, will have one last opportunity to do “whatever it takes” to protect the Euro and get the European economy back into a higher gear. Previous accommodative actions have not spurred growth, nor have they ignited inflation to hit the long-held target of 2%. Draghi has already talked about a potential rate cut, even when German 10-year bund rates are at a negative 30 basis points, very near their all-time low.

The ING Economic and Financial Analysis Group believes that actions by Draghi and the central bank may be drawn out: “The ECB is just about likely to stay on hold this week. We expect the dovish press conference, with guidance on a September rate cut and talk about QE, to weigh on the euro. The evolution of market expectations on ECB QE should be the prime euro-negative factor in the coming months.”

ING further elaborated: “Despite the market already pricing a 40% probability of a 10bp cut this week, more than one 10bp cut by September and close to 20bp overall easing by the end of this year, we see a downside risk to EUR/USD coming from the ECB meeting this Thursday.” Their thinking is that the ECB will only modify its forward guidance to signal future cuts, thereby confirming market expectations. They also expect Draghi to appear dovish at his press conference and hint at further quantitative easing down the road.

ING concluded that: “An adjustment of the forward guidance to incorporate the possibility of lower rates would set the central bank on a clear path to cut rates in coming months. This should put the focus on the front end of the curve as markets also gauge where the new lower bound in policy rates will be. The absence of an immediate cut this time around would probably mark only a minor and in our view a temporary disappointment.”

How might the Euro react over the remainder of 2019? The Euro has been in a general decline for the past year, falling from a highpoint of nearly 1.18 versus the USD, down to a twice-tested bottom in the May/June timeframe of 1.113, but after a modest recovery, it has returned to 1.113. FXStreet analyst Joseph Trevisani sees a shorting opportunity: “I’m looking at between 1.05 and 1.07 by the end of the year. Given the trends that we’re seeing, both as far as the central bank rates go and also the world economy, that seems likely.” He would place a Stop-Loss at 1.15, contending that major economic reversals would need to happen for that rate to be seen.

Since the Euro makes up 57.6% of the USD index, there would need to be strong performances from other components of the index for the greenback to actually weaken over time. The Japanese Yen is treading water at present. It could improve a bit versus the Dollar, but the Bank of Japan may still have to ease in order to push inflation higher. That leaves Pound Sterling, and the situation in the UK is not one that is conducive to a strengthening move in the near term.

What is the situation in the UK? Per press headlines: “Today, Boris Johnson was elected prime minister of the United Kingdom. His aim is to pull the UK out of the European Union, an action that most analysts believe will have a very serious effect on the British economy. So, the price of the pound falls relative to that of the US dollar.”

Prior to Johnson’s election, there had been tough talk from the Bank of England regarding interest rates, but Johnson’s intention is to cut rates before the end of the year. Brexit must occur in October for this plan to move forward, but the market at present is skeptical that the new leadership can pull off an exit in that timeframe.

How about the rest of the world? Outside of Europe, a global dilemma is building: “There are concerns about how slow the Chinese economy is growing and what economic policies are going to be let loose to turn this situation around. The world economy is not in very good shape and the actions being taken by many nations within this global dilemma seems to be exacerbating the situation. And, any actions taken by these countries to correct their position is grist for the tweets of President Trump, accusing these other nations of a direct attack on the economic policies of the United States.”

Concluding Remarks

As much as President Trump and his Treasury Secretary, Steven Mnuchin, want the U.S. Dollar to weaken, the more it stays strong, despite a host of economic reasons for why it should decline. If a growing deficit, national debt, and potential interest rate cuts will not cause the Almighty Dollar to bend a knee, then what will? It does not appear that any other economies are likely to bolt ahead out of the blue any time soon and supplant the U.S. in its current leadership role.

And so, the forecast for the USD is to possibly strengthen over the remainder of 2019, rather than the other way around. One observer opined: “In this changing world, the United States is still at the top and it must use this position to build a world of positive-sum opportunities. We must not fight others as if there can only be winners and losers.” The Trump administration, however, has shown no signs of building economic coalitions for the benefit of all participants. Protectionism has seemed to be his apparent strategy, which other nations appear to be emulating, as well. Trade will suffer, as a result, and economic prospects could get worse before they get better.

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Tom Cleveland
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