US Dollar Capitulates after Trump Hits Out at Federal Reserve, Talks Currencies

-US Dollar capitulates while other currencies rise Tuesday.

-After Trump criticises Federal Reserve, China and European Union.

-Comments unlikely to alter Fed policy but markets to watch Powell.

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The Dollar fell Tuesday after President Donald Trump lashed out at the Federal Reserve for its recent approach to US monetary policy, prompting fears of a slowdown in the pace at which the central bank raises its interest rate.

In a Reuters interview, Trump said he is "not thrilled" his choice of Fed chair, Jerome Powell, has continued to raise interest rates since taking the bank's top job in February. And he also claimed the EU and China are manipulating their currencies. 

Trump has made no secret of his desire for a weaker Dollar and has previously said he is not a fan of high interest rates, which make his agenda of boosting the US economy more difficult to implement.

"It looks as though these comments have caught market very long dollar after last week’s EM rout. But are they enough to turn the bull trend? Probably not – unless it looks like the Fed has independently assessed that there has been an unwarranted tightening of financial conditions and want to slow the pace of rate hikes. We’ll hear more from the Fed later this week," says Chris Turner, global head of FX strategy at ING Group.

Above: US Dollar effective exchange rate in 2018.

The Fed has raised interest rates seven times since the end of 2015, including twice in 2018, taking the Fed Funds rate range to between 1.75% and 2%. Many economists expect it to raise rates so the top end of that range hits 3.25% around the end of 2019.

Trump also claimed Tuesday that both China and the EU are keeping their currencies artificially weak. A weak currency improves competetiveness in trade terms by making export goods cheaper for overseas customers to buy. Trump previously threatened to declare China a currency manipulator, which would see it clobbered by fresh tariffs.

US, Chinese and EU officials have been at loggerheads over international trade this year, with the White House levying new tariffs on metals exported to the US from the EU and on more than $250 bn of Chinese exports to America.

"While the ECB is not directly manipulating its currency, you have to have some sympathy here for President Trump given the ECB continues with QE and negative interest rates despite the inflation rate sitting above the ECB’s target at 2.1%," says Derek Halpenny, European head of global markets research at MUFG. "Speculation that the Chinese authorities may be about to re-adopt the ‘counter-cyclical’ factor into the daily calculations of the CNY fixing means President Trump may have a point on China also."

The US is currently in negotiations with Beijing and Brussels aimed at curbing the former's frosty approach to foreign companies operating in China, and addressing the imbalance between Euro area and US trade tariffs. 

The "trade war" that preceded talks has put markets on edge in 2018 as many analysts fear it will lead to an economic slowdown in China and further afield. 

Above: Pound-to-Dollar rate shown at daily intervals.

The US Dollar index was quoted 0.25% lower at 95.49 during early trading Tuesday. The Pound-to-Dollar rate was 0.24% higher at 1.22834 and the Euro-to-Dollar rate was 0.26% higher at 1.1521.

These "trade war" fears, have helped maintain a bid for the Dollar in recent months. Dollar strength was the main driver behind a 9% decline in the Pound-to-Dollar rate and 8% decline in the Euro-to-Dollar rate over the same time period. But the greenback's outperformance has not been solely the result of trade tensions.

Most analysts now agree it has been driven in large part by a superior US economic performance, which enabled the Federal Reserve to go on raising its interest rate this year at a time when the outlook for monetary policy elsewhere in the world was deteriorating. However, there are now signs this could also be changing. 

The economic surprise indices for the Euro area and US economy are converging once again, albeit because of a series of recent disappointments in US data and not upside surprises in anything emerging from Europe. While not enough to have analysts rushing out to buy the Euro, it does remove the incentive to sell it and buy the Dollar instead. 

"There has been some convergence in the economic surprise indicators of the US and the Eurozone which could be EUR/USD supportive. And a break of 1.1530 could carry EUR/USD to 1.1600 in thin markets – but as noted above a sustained turn-around in the bear trend probably requires a less hawkish Fed or a surprisingly upbeat ECB - neither of which seems imminent," ING's Turner adds. 

Above: Euro-to-Dollar rate shown at daily intervals.

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