Trump's Progress on Tax Reform Aids US Dollar Revival vs Underperforming Pound and Euro

The US Dollar is in the driving seat and dictating play on global currency markets as traders prepare for an upcoming meeting of central bankers in Wyoming and US President Donald Trump finally makes some progress on tax reform.

US markets and the Dollar rose with, "fresh hope of moves on US tax reform apparently providing the catalyst for gains. Warm words from Senate leader McConnell on the debt ceiling are also helping to boost confidence,” says Chris Beauchamp, an analyst with IG.

Politico reports Trump’s top aides and congressional leaders have made significant strides in shaping a tax overhaul, “moving far beyond the six-paragraph framework pushed out in July that stoked fears about their ability to deliver on one of the GOP’s top priorities.”

“There is broad consensus, according to five sources familiar with the behind-the-scenes talks, on some of the best ways to pay for cutting both the individual and corporate tax rates,” adds the report.

This will be music to the ears of Dollar-bulls.

Recall that the US Dollar rallied strongly in the wake of Trump’s election victory with investors anticipating sizeable tax cuts and infrastructure spending promises?

2017 has been a story of those gains being reversed as Trump’s multiple setbacks in Congress told markets that the President simply does not command the gravitas to push through his personal agenda.

If those promises can in fact be delivered, then the Dollar certainly faces a brighter end to 2017.

“We are seeing a bit of a correction in the Dollar on the back of two things,” says Brent Donnelly, a spot FX trader with HSBC:

1) “Some position adjustment into Jackson Hole.”

2) “A pretty weak article on Politico. With nothing priced for tax reform I guess any
hope is better than nothing.”

A weak story or not, the Dollar is enjoying strength - the Pound to Dollar rate is 0.5% higher, the Euro to Dollar is 5% lower with the Dollar index 0.47% higher. What does this tell us? The Dollar is in the driving seat with the other major currencies taking direction from the Greenback.

Jackson Hole Symposium Looms Large

Mario Draghi appears at this week's Economic Symposium in Jackson Hole, Wyoming and markets are nervous of what he will say. (C) European Central Bank.

The Euro is meanwhile underperforming the Dollar and being kept in check by Pound Sterling as investors exercise caution ahead of an appearance by European Central Bank President Mario Draghi at conference later in the week. 

“Ahead of the Jackson Hole, the US Dollar's selling has paused for the time being,” says Fawad Razaqzada, an analyst with Forex.com. “Having trended lower for much of this year, most of the bad news might be priced in. So without any fresh catalyst from either the US or elsewhere it may refuse to significantly fall further.”

It would appear that much of the currency market’s current moves might be coming in anticipation to what might be communicated by global central bankers at the Federal Reserve Bank of Kansas City's Economic Symposium, due to be held August 24-26 in Jackson Hole, Wyoming.

Central bankers tend to use the event to signal important policy changes, think of Mario Draghi signalling the commencement of the European Central Bank's quantitative easing programme back in 2014.

Markets are concerned Draghi might fight back against Euro strength at this year’s appearance.

“The market is primed for central bankers’ to talk down their currencies, which means that any ‘hawkish’ talk may cause the biggest waves in financial markets. The focus will be on the ECB’s Mario Draghi and the Fed’s Janet Yellen,” says Kathleen Brooks at City Index.

The minutes of the ECB's July policy meeting revealed some members of the Bank's governing council to be concerned the Euro's rise could nip economic growth in the Eurozone.

If Draghi agrees he might wish to push this message at Jackons Hole and quell enthusiasm towards the single-currency.

City Index believe that Draghi will likely tread cautiously and won’t give anything away about ending the ECB's Asset Purchase Programme. “While he may acknowledge growth has picked up, he is likely to sound concerned about inflation and may even reiterate the ECB’s concern about an Euro overshoot to the upside.”

The Dollar meanwhile appears least at risk to central bank chat, hence an apparent rush to Dollars amongst investors.

The Federal Reserve’s Janet Yellen is the one to watch, argues Brooks:

“Her time as Fed Chair most likely coming to an end in January, which may cause her to throw caution to the wind. Yellen may use the Jackson Hole conference as an opportunity to explain why the Federal Reserve has been willing to hike interest rates even while inflation has been slowing. Her argument in support of rate hikes in a low inflation environment could be perceived as hawkish, which is likely to be dollar positive in our view.”

This leaves a resumption of last week’s stronger Dollar trend as the most likely outcome from this Jackson Hole conference argue City Index.

Concerning the outlook, the GBP/USD exchange rate is looking vulnerable to weakness having been in an uptrend over recent months.

While the GBP/USD is approaching significant support levels, the same is not true for GBP/USD which has a good chunk of ground to concede without looking oversold.  

“Sentiment towards the British pound remains negative and so if the dollar were to stage a more meaningful comeback then the GBP/USD would be the one to watch as it could drop heavily. At the time of this writing, the GBP/USD was testing last week’s low at 1.2830,” says Razaqzada.

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Could Dollar Strength be Short-Lived? These Investment Banks Believes So

While the Dollar is looking strong at present, the extent of the strength is questionable.

We report today that analysts at the world’s largest investment bank, J.P. Morgan believe the US Dollar will remain under pressure through the remainder of 2017.

Analysts at the investment bank warn that inflation will likely remain tepid over coming months which will in turn ease pressure on the Federal Reserve to raise interest rates.

“US inflation continues to surprise to the downside – five consecutive months, which has only occurred once previously in the past 20 years – leading to one of the flattest US money market curves so far in this Fed cycle,” says John Normand, analyst with J.P. Morgan in London.

Furthermore, J.P. Morgan believe President Trump’s policy missteps and waning popularity makes for a potentially difficult debt ceiling negotiation.

Political risk therefore remains a key concern, something picked up on by Lee Hardman, Currency analyst with Bank of Tokyo-Mitsubishi UFJ:

"Heightened US political uncertainty could add to concerns in the coming months ahead of the required debt ceiling extension in the autumn. US Treasury Secretary Mnuchin provided reassurance when he stated that raising the debt ceiling was priority for the Trump administration when Congress returns.

"The US Dollar has weakened in the run up to the previous two debt ceiling stand offs and thereby poses some downside risk for the US dollar in the coming months."

As a result, J.P. Morgan upgraded their Pound to Dollar forecast to 1.30 from 1.28 for year-end 2017.