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Dollar bulls need the Fed as well as Trump

The calendar may have only just flipped into March, but it has already felt like a long year for dollar bulls.

They have been frustrated with the wait for detail from Donald Trump on the proposed tax and fiscal policies that started their run at his election in November. It is a rally that has faded in 2017, with the US currency down 0.25 per cent this year.

While the president’s address to Congress this week contained few specifics, the buck is on the up again. The rebound is reminiscent of its immediate post-election advance — when strong US data, the prospect of monetary policy normalisation and the president’s promises of fiscal stimulus and tax reform — evoked talk of a new era of dollar strength.

If the US currency can rise when the president disappoints investors, are his economic pledges becoming less important? The answer will go some way to determining the pace and duration of what, one way or another, most in the foreign-exchange market still expect to be a period of dollar appreciation.

The latest advance, which pushed the yen down to below ¥114 to the dollar and restored the index that measures the greenback against its peers to levels last seen in mid-January, is attributed by many to the markedly hawkish tone of a number of Federal Reserve officials.

1. Dollar climbs on hawkish Jackson Hole speech from Fed chair Janet Yellen

2. Trump wins election and promises to unite the US, sparking dollar rally

3. Robust data pushes dollar up to 13-year high

4. Federal Reserve raises interest rates

5. Trump’s combative pre-inauguration press conference sparks investor uncertainty

6. Market expectations of rate rise exceed 80 per cent following confident Fed talk

Yet Simon Derrick, head of BNY Mellon’s markets strategy team, says trying to separate the influence of expectations for higher rates from those of Mr Trump’s promised policies in the dollar’s rise this week is pointless.

“I don’t think you can split the two,” he says. “You can’t say, ‘that’s the speech, that’s the Fed’. They are both playing a role, in the same way they played a role back in November.”

Even so, some investors are feeling a good deal less sure about the Trumpflation trade and the president’s capacity to deliver economic stimulus, despite the emollient tone of his speech.

The wait for detail from the White House has left the dollar “stuck between opposing forces”, says Stephen Jen at Eurizon SLJ Capital, not helped by Mr Trump’s policies that have turned out to be “more shock than awe”.

This week’s dollar boost, while significant, still feels somewhat muted compared with moves in the bond market. Jumps in two-year Treasury yields normally trigger big dollar volatility, says Mr Derrick. The last time, for example, the gap in yield between two US government notes and their German equivalent reached 215 basis points was in mid-2000, when the euro was worth 90 cents.

Yield movements may be commensurate with the big November shifts, “but what’s out of whack is the dollar”, says Mr Derrick.

Dollar bulls may receive further help on Friday when speeches by Fed chair Janet Yellen and her deputy Stanley Fischer should show whether the market is justified in this week driving expectations of a March rate rise to 90 per cent.

According to portfolio manager Alessio de Longis of Oppenheimer Funds, while the fiscal stimulus and tax story has become “more muted”, the Fed “is going to be front and centre” for investors.

That will keep the dollar on an upward path, says Mr de Longis, “but I’m now planning for a more gradual dollar appreciation trend rather than a more violent one”. What keeps Mr de Longis optimistic is not Mr Trump’s proposed policies, nor rate increases, but the momentum in global growth.

Yes, there has been a period of headlines and uncertainty over political risk, Mr de Longis admits, “but headlines and uncertainty matter much more when growth momentum is weak, and the growth momentum hasn’t looked this good globally in a couple of years”.

The Trumpflation trade is by no means dead. Investors may be swallowing a heavy dose of scepticism about the president and his ability to deliver, but Mr Jen expects the Trump trade to come back into fashion this year as his tax proposals are fleshed out.

The dollar may look “a bit messy”, he says, and the temptation is to steer clear of currency trades, “but I still think the dollar goes higher later this year because of Trump”.

Others are less convinced about the dollar’s longer term prospects. Luca Paolini, chief strategist at Pictet Asset Management, says the currency is expensive and the trade is overcrowded.

Added to that, he says the Trump White House has signalled that the strong dollar policy of previous administrations is in peril; the International Monetary Fund reckons US growth will underperform the average of advanced economies in the next five years, and history suggests the Fed will over time lean towards a more dovish stance.

“The dollar may overshoot in the short term if the Fed sounds more aggressive but the trend is down,” says Mr Paolini.

A good week for the dollar will give encouragement to the bulls, but may yet turn out to be a high point.

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