USD: Guided by politics or economics? - Rabobank

Trump may has disbanded two high profile business advisory councils recently but the fact that this was a response to eight executives quitting has been difficult to ignore and will have significant impact on the direction of USD, according to Jane Foley, Senior FX Strategist at Rabobank. 

Key Quotes

“Either way the administration will lose the insight offered to it by corporate executives.  Not only is this a concern for the US markets but fears that Trump is expending more energy in fighting scandals rather than concentrating on policy have also been fuelled.   In short, there is now even less reason to hope that the Trump Administration will be able to offer significant fiscal reform.”

“In addition to a negative impulse from political developments, economic news has also undermined the USD.  The minutes of the July 25-26 meeting indicates that some Fed officials are worrying about the lack of inflation being generated by the US economy.”

“It is our view that the Fed will not hike rates again this year.  The indication from the FOMC that balance sheet reduction may also commence soon provides further reason for policymakers to be wary about raising rates too soon.  In June the FOMC provided detail about how balance sheet reduction would take place.  It has not yet, however, provided clarity on timing.  Although the Fed’s Jackson Hole event (August 24-26) will be watched closely for clues, the market is poised for more detail in September.”

“In theory balance sheet reduction is USD positive since it is a drain of liquidity from the system.  That said, the Fed have signalled a cautious approach to tackling its USD4.5 trn balance sheet.  In June the FOMC made clear that its will only decrease the reinvestment of the principal payments.”

“These payments will only be reinvested to the extent that they exceed gradually rising caps. It is also clear that the Fed will not attempt to reduce the balance sheet to anything like its pre-QE size due to growth in the public (US and foreign) demand for currency.  Assuming a continued increase in need for currency due to rising GDP, relatively low rates and increased foreign demand, the Fed’s balance sheet will naturally grow.  This implies that the Fed will over time grow into a larger balance sheet requirement.  That said, a reduction in asset holdings the coming month short provide the USD with support.”

“In contrast to yesterday’s negative USD factors the upward revision in Eurozone Q2 GDP to 2.2% y/y provided a reminder of the relative improvement in EUR fundamentals this year.  While we expect the pace of EUR/USD upside to slow, we are forecasting a move to EUR/USD1.20 on a 12 mth view.”