These days, trading the USDINR pair, is like eating a cheese burger. The juicy patty is possibly 100 pips wide between 67.00 and 68.00 and anything above and below is the less tasty bun. Since January 2016, prices have been oscillating between 66.00 and 69.00 levels on spot, with bulk of the trading concentrated between 67.00 and 68.00 levels on spot. As a trader, making money within this range is relatively easy when prices are trading within the 67.00 and 68.00, than above or below, as the central bank gets super active. In such scenario, weird intra-day and even intra-week spikes can throw you out of the trading positions. It is more likely that the pair remains in this “burger range” for more time to come, which means, traders may have to become more nimble in scratching nickel out of the purse of the central bank.
Last week top-tier US economic data was unanimously strong, with solid readings on inflation (consumer and whole sale level), retail sales, and a multi-year highs in regional surveys conducted by various agencies. Even Mr. Trump talked about unveiling a “phenomenal” tax reform plan and Fed Chair Janet Yellen was hawkish in her semi-annual testimony, noting that it was “unwise to wait too long” to raise interest rates. However, inspite such a show, US Dollar put up a mixed performance. USD gained against Euro, as the latter was undermined by rapidly changing landscape of the French presidential polls. Pound declined after a week-long disappointing economic data from UK. Yen gained, inspite of the widening yield differentials in favour of the US Dollar.
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Since the beginning of the year, US Dollar has come under selling pressure. There can be numerous reasons for the US Dollars weakness but I would like to highlight three of them:
One of the most straightforward, in my view, is that the “long dollar” trade was simply too crowded at the start of the year. With various positioning metric and sentiment indicator indicating a speculative overweight, market was not left with much ammo to drive prices further upward.
On one hand, Trump administration has supported the US Dollar by talking about lower taxes, less regulation and more fiscal spending. But on the other hand, they undermined the Greenback by talking about protectionist measures and “weak Dollar policy”.
Political risk has never been higher in America in recent times. The open war between Mr. Trump and much of liberal media and the also with bureaucracy is not being taken kindly by markets. Mr. Trump has started his own version of media through twitter. A few months back, who would have believed if they were told that American President would be at war with media and engage in acrimonious public war of words with them? He or She would use twitter like any Joe would be using to communicate his views and policies. It is interesting times but not at all unexpected.
A cocktail of the three narratives is not allowing traders to latch onto any dominant narrative to bet large sums on any direction. They are happy to chase equities higher world over. Infact it is not just equities, commodities too have continued to march higher. A perfect reflationary trade which is underway. Sentiment indices world over have recovered from the nadirs of 2015 and 2016. There is a feeling of “spring in the air”. After all, if America, the biggest exporter of demand in the world economy, decides to pump prime its economy, there are valid reasons why economic agents should be optimistic. However, we expect nasty surprises in how this narrative unfolds.
There are two possibilities about Mr. Trump. Either he is a person whose mission was to just become the US President and show to his opponents what he is capable of. Or, he is serious about his political career and wants to leave a successful legacy when he leaves Oval office. Assuming it is the former, I strongly believe that Mr. Trump understands that his political survival is dependent on the support of his core voter- American who believe they have been handed a raw deal by the globalists and they have been marginalized by globalization. Therefore it is of utmost importance that Trump administration is able to deliver on the promise of more jobs in America. If the world economy was not caught in a supply glut or demand deficiency, then the job may have been easier for Mr. Trump. But it is still doable but at the expense of other economies in the world.
America has to become smartly protectionist to create better economic growth. US follows an open border policy as far financial flows are concerned. With efficient and robust capital markets and high social capital, it is no surprise it attracts so much of speculative and investment flows into the country. US Dollar being a currency which can be procured by any central bank without any restriction. Any country can use the capital flow channel to extract demand from there. Remember economics 101, current account is the difference between savings and Investment, or net savings in the economy and current account and capital account should balance, the famous economic identity. Therefore, if capital inflows surge and surplus in the capital account increases, current account has to show a similar increase in deficit to balance the two. Current account being net savings, hence, a current account surplus nation is a country who is a net supplier to the world economy and the country with a current account deficit, is a net purchaser. Therefore, as capital flows surge into America from countries with current account surplus, America needs to export more demand from its local market. More they export demand from local market offshore, lesser goods and services are produced and serviced onshore. Yes we can blame automation for job losses, but that is not just an American problem but a global issue. Infact technology led unemployment is a bigger threat for countries in emerging world with high population and low per capita GDP.
Trump administration need to enact smart protectionist policies and dumb ones to support the economy. For example, proposal from Sen. Ryan to tax imports should be implemented not selectively but on a blanket manner. It will be foolish from economic perspective to opt for a border tax or any other protectionist measure with one or two countries, because in that case, its current account balance would simply shift from region to other. However, having a blanket tax on imports and even considering a policy to devalue the US Dollar would help US economy. It will make imports expensive and as a result consumption will fall. However, at the same time, domestic producers will be incentivized to substitute the higher priced goods and services with domestically produced ones. This coupled with low taxes and less regulation would augment GDP. Higher GDP would create more employment opportunities for local population. All in all current account, which is a difference between output and consumption and investment (private and government) would become less negative. As a result, America would be exporting less demand to world markets. That will be bad news for countries who run large current account surpluses. They will have to create their own consumption boom, which difficult due to low share of household income to national income, or face rising unemployment. I presume, the above argument may come as so counter intuitive to ongoing narrative in media nowadays that protectionism is all bad news for America. I would write about it in greater detail in the future articles.