As we’ve seen across most of the developed countries, US Q1 economic releases highlighted some weakness in performance. A combination of an aggressive protectionist skew in president Trump’s policies along with volatility in financial markets, weighed on USD over the first three trading months of the year. However the USD rally continues as Q2 outlook picks up. The outlook for Q2 looks far better, despite some provocative moves by President Trump such as him pulling out of the Iran nuclear deal, which have boosted his approval ratings among voters, even in the midst of ongoing scrutiny of his personal conduct.
March & April Data
Q1 output growth was 2.3% annualised which is a good figure, although it does mark a decline from the prior three quarters. The majority of the negative contribution came from January and February, while momentum seemed to pick up again in March with consumer confidence, spending and labour market data all printing better in April. Forthcoming tax cuts and stronger incomes should continue to boost domestic demand while next exports are also looking firmer.
Better Wage & Inflation Data Supportive of Continued Fed Rate Hikes
Although average hourly earnings data is still quite subdued, the broader employment cost index is rebounding strongly and other survey data sets indicate that pay is rising. The National Federation of Independent Business reported that the total percentage of businesses granting pay increases has only been higher in one other year out of its 34-year history.
In light of this wage environment, the current forecast of three more rate hikes by the Fed this year seems appropriate. There is also likely to be increased upward pressure on the long end of the yield curve as the market becomes more aware of upside inflation risks.
Yields could also see an additional rise due to the upcoming fiscal deficit which is due to hit next year, of 5% GDP, along with the Fed running down its balance sheet. Furthermore, the constant threat of trade war escalation could see China becoming more erratic and unpredictable at US Treasury auctions, which increases the risk of seeing failed auctions. This would exacerbate financial market volatility, damaging investor sentiment.
China Trade War
Trade tensions between the US and China have dominated the markets over recent months and though the rhetoric from both sides has receded somewhat, concerns still remain. The US has demanded that China reduce its $340bln trade surplus with the US by around two-thirds over the next two years along with refraining from engaging in any counter measures. The market is not convinced that China will be co-operative with these demands and even if it is prepared to co-operate, it would be difficult for China to deliver such a reduction in the surplus as US tax cuts are likely to fuel further US purchases of cheaper, foreign goods.
Support for Trump Rising, but Not for The Republicans
Recent opinion poll data shows that support for President Trump has risen recently despite ongoing scrutiny over his personal life including high profile “cash for silence” scandals. However, this personal support is not translating into broader support for the Republican party who are still lagging the Democrats by 7 points on average. The Republican’s loss of Pensylvania’s 18th District in March is a clear red flag for the party and given the long time association of the state with coal and steel it suggests that although some might be in favour of aggressive trade protectionism, overall, voters are not happy with the Republicans.
Risk of Republican Loss in November Elections Growing.
With the mid-term elections in November growing on the horizon, there is an increased risk that the Republican party will lose control of the House. If this does indeed come to be, this will place further restrictions on the President’s ability to pass legislation as well as his nominations for any judiciary posts or posts in other areas. Furthermore, the Democrats capacity for launching investigations into Trump and his administration which would likely once again stoke up talk of impeachment.
After two months spent consolidating at the 61.8% retracement from 2014 lows, USD has since rallied strongly higher to make it back above the broken 50% retracement level and is now challenging the broken long term bullish trend line, which for now is acting as resistance. While still above the 50% retracement level, focus will be on further upside. USD Short exposure continues to be unwound, supporting the rally for now, though if this starts to peter out w could see another block of consolidation form.