The US Dollar is lower this morning on the back of a surprising “verbal intervention” from President Donald Trump that broke decades of tradition to criticize the Fed's interest rate policy. The US President said that he's “not thrilled” to see the central bank raising borrowing costs and Dollar's surge is now in doubt. Would this development affect the Fed's rate hiking path and is there a case to be made for a weaker Dollar during the rest of the year?
We believe that such a case could be made but only towards the end of 2018 as the short-term outlook for the greenback remains positive and the Fed has everything it needs to justify raising rates for the third time after the end of the summer. The strength of the labor market and positive progress in all production metrics suggest that the US economy is strong enough to handle higher interest rates at this time. But what about later in the year? Which are the factors that would threaten a continuation of tightening and eventually drive the Dollar lower?
Our focus is fixed on two key factors: the developments on the trade war front and energy prices. It is clear that a prolonged trade dispute would put the US economy under stress. If tariffs are imposed on US products by all the parties threatened by Donald Trump, namely China, the Eurozone, Canada, Mexico and others, then it would be hard for US growth not to be affected. At the same time, if Oil prices fail to recover near the $75 area and eventually break higher then inflation expectations will have to be re-adjusted lower.
A slowdown in domestic growth and a downtick in inflation will force the Fed to reconsider their 4th hike this year. And with markets and investors always being forward looking, if these two factors start materializing after the end of the summer it's clear that bets towards a stronger Dollar will start reducing. And if we add to that yesterday's reminder from Trump that he prefers a weaker Dollar - the cornerstone for his plan to reduce the trade deficit with China - then a key turning point in Dollar's outlook might be just down the road.
Price action today will take its cue from Dollar's momentum and it seems that the end of the week will not be positive for the US currency. The Dollar Index is testing a key support level at the 95.00 mark and a break below this level would trigger a coordinated decline for the currency against all of its peers. The Euro could hit 1.1750, the Pound rally to 1.3150, Dollar/Yen move towards 111.50 and Gold reclaim the $1,235 area.
Equities had a bearish day yesterday but the Asian markets are trading mostly above water at this time. The European and US futures are mixed but most bourses are trending towards a mildly negative opening bell. The US earnings' season is the key point of focus at this time but it will be very interesting to see whether equity traders will respond to President Trump's remarks. Clearly the prospect of a slowdown in the Fed's rate hiking schedule would help equity markets to break above recent highs so it remains to be seen whether this will affect the sentiment in equities today.
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