Trumpeting the US Dollar
by George Hatjoullis
The DXY is a weighted index of currencies expressed in terms of the US Dollar. A rise in the index represents a strengthening of the USD. The index is dominated by the Euro and Japanese Yen (about 70%). DXY is a volatile financial instrument as can be seen from a longer history. It has also, arguably, broken out of a long-term downtrend. The above chart seems to signal that it has now confirmed a continuation pattern. This implies that after a brief pause, and perhaps correction, the DXY will continue to rally and at least as much as the move since 2014.
How does this square with the Trump era? The world is moving into a dark phase in both economic and political terms. Nationalism and protectionism are in the ascendancy and supranationalism and globalisation are under attack. Trump is promoting ‘bringing it back to the US’ and this involves a great deal of tax-shy cash as well as production. The implied break on world trade growth certainly does not favour Japan. The implied threat to the EU does not favour the euro. In broad brush terms, a continued strengthening of the dollar is not an implausible scenario. If Trump follows through with his easy fiscal policy and the Fed counters with tight money we also have a domestic policy regime that supports a stronger dollar. The precise timing and pattern of dollar strength needs more refining but as a broad statement one can assume the DXY will move up over the course of 2017 and probably 2018.
Another important positive for the USD is that oil is increasingly moving west to east, reversing the pattern of decades. This was pointed out by Spencer Dale, chief economist for BP. The US is well placed for autarky and thus the USD should do relatively well in a de-globalisation phase. The fossil fuel market is changing structurally but it will not change that much over the next year. The strong dollar will, as I have argued in the Oil Price and the US Dollar, continue to cap the oil price. It should also act to suppress the gold price.
The EU has a large internal market but it is not self-sufficient in fossil fuels. It is progressing in substituting alternatives but is somewhat short of self-sufficiency. It is also hampered by an attitude to fiscal policy that ensures it will have a policy mix, tight fiscal and easy money, that does not favour the euro. In addition the rise of nationalism poses an existential threat to the whole EU project. It is going to be difficult year for the EU and the euro zone. Japan is still geared to trade and seems incapable of domestically generated growth. It only has one policy tool left, monetary financing, and it may never choose to deploy.
Making long-term currency predictions is difficult. My profession required that I made them on a regular basis despite my scepticism as to the possible accuracy. The assumption that the DXY will continue to rally somewhat is however hard to avoid and is a good place to start.