While the dust has to settle from the shock of the 2016 Presidential Election, the fundamental forces that effect currency direction were clarified and unleashed on election night.
A key lesson is that forex prices and their technical patterns do not efficiently predict direction. Clearly, the fear of a Trump win manifested itself as being bearish the dollar. This fear triggered safe-haven rallies in gold and a strengthening in the yen. On election night, the U.S. dollar/Japanese yen (USD/JPY) currency pair and gold first rallied and then quickly made U-turns. Was this pattern unusual or irrational?
The best way to understand the election night behavior of the U.S. Dollar Index, gold and the yen, was that prices are always essentially a balance of “expectation waves.” The fundamentals affecting expectations were essentially psychological as “fear” and “uncertainty” were dominant emotions. However, it was classic swarm behavior with expectations shifting from bearish despair to a bullish post safe-haven relief rally.
With the election over, currency trading strategies need to be cognizant of expectations with the following three fundamental and psychological components.
1- Super Dollar Bullish Sentiment: In 2017, as the Federal Reserve Bank moves to increase U.S. interest rates, traders should look to be long the U.S. Dollar. A stronger dollar is likely to continue if the Fed signals a potential to increase rates more than once in 2017. These fundamentals on the roadmap for increased rates existed before the Trump victory. But a Trump Presidency gives ascendency to a bullish “Trumponomics” psychology from expectations of strong fiscal stimulus focusing on infrastructure.
The result is a super bullish expectation wave. The 2017 dollatr outlook is bullish. A strong dollar wave will also weaken other currencies. A key consequence is that central bank rate decisions in 2017 will likely shift away from further cuts and greater monetary stimulation as they welcome a stronger dollar as providing opportunities to import inflation. The U.S. dollar bull is doing the job for the other central banks.
2- The Great Yen Weakening: Traders should pay attention to the USD/JPY. In 2016, having probed near 100 several times, the yen has shown that fundamentally and psychologically, it cannot be too strong for too long. Safe-haven strengthening of the yen is temporary in nature as its economy suffers from negative interest rates. On Nov. 3, the USD/JPY was 102.98 and as of Nov. 15, the USD/JPY rose to 109.13 (more than 6% increase in value is a game changer for 2017 as all previous 2016 highs have been taken out) clearing the way for a larger rise in the USD/JPY pair. Therefore, consider buying the USD/JPY in 2017 on dips to 115 with further targets to 120, especially if U.S. rates increase twice in 2017.
3- The China-Trump Factor: We need to apply the lesson learned on election night that psychological expectations are a key component of fundamental forces. Conventional wisdom provides a bearish outlook for Sino-U.S. relations. Trumponomics wants a stronger RMB against the U.S. dollar, to decrease China’s competitive advantage on export prices. The Chinese want a stable economy and need export stimulation. Also, the RMB can strengthen against a basket of currencies, yet still weaken against the dollar. The result is an element of ongoing risk and uncertainty. The gauge for this will be volatility in the Shanghai Index, which will register the balance of expectations in this Trump-China conflict. Traders should not blindly follow conventional wisdom. The new administration will likely look to make short-term deals on China trade relations. If successful, a positve outcome is possible.
All signs point to the emergence of the Super U.S. Dollar bull market in 2017.