Dollar at Risk as Trump Takes another Step Towards Intervention

Image © White House

- President Trump argues again for Fed cuts and a weaker USD. 

- Analysts growing wary of possible White House USD intervention.

- Comes as ECB and others go for rate cuts and weaker currencies.

- Threat grows amid 'dovish' candidate nominations for Fed board.

- USD thumbs nose Thursday but eventual reaction may be severe.

The Dollar was steady Thursday after thumbing its proverbial nose at President Donald Trump's latest attempts to lobby the Federal Reserve (Fed) for interest rate cuts and a weaker currency, but analyst concerns about the interventions are growing and any eventual reaction by the greenback could be severe. 

President Trump accused China and Europe late Wednesday of using central bank policies to gain competitive advantage over the U.S. by manipulating their currencies, before arguing the Fed should do the same. This is the latest in a long line of attempts to influence Fed policy and weaken the Dollar. 

China and Europe playing big currency manipulation game and pumping money into their system in order to compete with USA. We should MATCH, or continue being the dummies who sit back and politely watch as other countries continue to play their games - as they have for many years!

— Donald J. Trump (@realDonaldTrump) July 3, 2019

"After Trump's FX manipulation tweet - we should be on high alert for active White House policy steps to weaken $USD. One way -> Treasury FX intervention: * 1988-1990 last time US unilaterally sold $'s * Done via ESF facility," says Viraj Patel, a strategist at Arkera. 

Some firms and analysts including Patel have long warned of the various tricks President Trump might try in order to weaken the Dollar.  

Above: Dollar Index at monthly intervals, annotated for milestone events. Click for larger version.

"That’s as open an attempt to jaw-bone the USD lower as one will ever see - and perhaps a threat to do more than jawbone," says Michael Every, an emerging market strategist with Rabobank in Singapore. "The president is both publicly belittling the Fed more than I do, openly introducing doves to its board, and speaks of open currency manipulation. There is open chatter of de-dollarization even in the mainstream financial media."

Trump has a long history of arguing for a weaker Dollar from even before his days as President but since being elected he's continued to claim the U.S. currency is overvalued and argue for a weaker greenback, leading some in the market to fear the lengths he might go to in order to achieve this apparent aim. 

That history saw analysts expressing concerns about the White House's likely Dollar policy within days of the 2016 election and barely more than a fortnight after Trump had been inaugurated they were speculating the new President would attempt to weaken the U.S. currency, although by then they had even more reason to do so. 

Trump said in January 2017 the Dollar was "too strong", although at the time the Dollar Index was above 100 and at its highest levels since shortly after the dawn of the new millenium. Only it's since fallen from a peak above 103 in 2017 to barely 96 on Wednesday, but the White House is still on the warpath.

"The US President’s intensified attacks on what he calls the “currency manipulators” China and Europe are increasingly creating the impression that he is prepared to risk a currency war. That would explain why Trump is stepping up the pressure on the Fed," says Thu Lan Nguyen at Commerzbank.

Above: Dollar Index at monthly intervals. Annotated for milestones and captures 2000 era peaks. 

"The whole of the US yield curve is now under the 2.5% upper bound of the Fed Funds target range. 30-year yields ended yesterday at 2.47%, their lowest level since October 2016," says Kit Juckes, chief FX strategist at Societe Generale. "The last time the whole US curve was inverted in this way and a recession didn't follow, was in 1986." 

A strong or strengthening currency can be problematic because it raises the cost of exports, which risks making them uncompetitive, and creates an incentive for domestic companies and consumers to buy more imports which hurt the economy because they're a subtraction in the calculation of GDP.

Trump was elected in part on a pledge to get the economy growing at rates rarely seen since before the financial crisis. 2018 was a stellar year for the economy, which was supported by tax cuts, but since then the market consensus has strongly favoured an economic slowdown this year and next. 

With 2020 being an election year that follows 12 months of trade war with China and multiple confrontations with trade partners including some allied countries, the White House may now be feeling increased pressure to get the economy growing at faster rates again. 

"Since 1995, the US has only intervened in the FX market twice - against the yen in 1998 and the euro in 2000," Juckes writes, in a research note Thursday. "Even so, it's worth noting that while the US ignored complaints of ‘currency war' when the dollar was weak in 2010, those comments were a decent predictor of the dollar's turn higher in 2011. At the very least, the President's remarks reflect the fact that the dollar is too strong."

Above: US Dollar Vs  Turkish Lira and Argentine Peso (orange line, left axis) January 2018-present.

"The US President thinks he has the right to demote Fed Chair Jay Powell. And he can nominate candidates for the Board of Governors," Commerzbank's Nguyen writes to clients Thursday. "If Trump were to go as far as ordering FX market interventions that would constitute a clear signal for the market that he intends to follow words with deeds, and that would mean that if push came to shove he may not hesitate to go for Fed chair Powell either. I don’t think that I will have to explain to you how the dollar would react to that."

The Dollar index was lifted by 4% in 2018 after the Federal Reserve raised interest rates four times, which came during a period when other economies across the world were slowing and investors were fearful of possible interest rate cuts in those jurisdictions. 

Changes in interest rates are normally only made in response to movements in inflation but impact currencies because of the push and pull influence they have over capital flows, and their allure for short-term speculators.

Capital flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. Rising rates have the opposite effect.

Interest rate rises reduce inflation by deterring activity that would increase economic demand and lift price pressures. One way they do this is by making new projects more expensive  and traditional bonds or bank deposits more appealing to capital owners, given the higher returns then available.

The same mechanics around interest rate rises also work in reverse with rate cuts and unconventional monetary policies like quantitative easing. Its the reverse scenario and challenges that explain why the European Central Bank is on the verge of cutting rates again and drawing the ire of President Trump.

"The weakening US economic outlook and building Fed rate cut expectations are increasing downside risks for the US dollar although it continues to remain strong," says Lee Hardman, an analyst at MUFG. "President Trump’s desire for a weaker US dollar is well known now which is limiting the impact of his repeated comments. The words would have to be backed up with policy action to have more impact on weakening the US dollar."

Above: Pound-to-Dollar and Euro-to-Dollar rates shown at daily intervals.

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