As we've been highlighting for the last couple of weeks, the blind, buy-everything-but-bonds "Trump Rally" was begging for a bit more nuanced analysis (see "Trumpflation" is still thriving, but 'Trumphoria' is fading away" and "How to know if the 'Trump Rally' is running out of brea(d)th" for more).
In defiance of traditional market correlations, U.S. stocks, commodities and the US dollar all rallied in sync through November and December, leading some traders to conclude that the usual intermarket relationships had been repealed. We were always skeptical of that notion, and based on today's comments, it's becoming increasingly clear which "leg" of the bullish "Trump Trade" is most vulnerable: the dollar.
In today's Financial Times, Trump's top trade adviser, Peter Navarro, trained his sights on a new target: Germany. The head of the new National Trade Council did not mince words, calling the euro "grossly undervalued" and an "implicit Deutsche Mark" that Germany was using to "exploit" other countries in trade. These strong words follow on the back of comments that from both Treasury Secretary nominee Steve Mnuchin and Trump himself that the U.S. dollar was "too strong," in addition to the ongoing threats to label China as a currency manipulator for keeping the value of its currency artificially low. This persistent drumbeat of dollar-bearish comments has taken the dollar index back to the 100.00 level from a peak at nearly 104.00 at the turn of the year.
Taking a step back, it's not surprising that the new administration is trying to talk down the value of the dollar from multiple angles; after all, a weaker dollar would provide a clear tailwind to Trump's top economic goals, namely creating a US manufacturing renaissance and boosting domestic economic growth to the 3-4% range. A weaker currency tends to boost exports and reduce imports, and all else equal, can provide a short-term boost to economic growth.
That said, the "all else equal" caveat is a big one: it's unlikely that U.S. trade partners will merely sit by and allow the Trump administration to push the value of the dollar lower, to say nothing of the executive branch's intense focus on "renegotiating" existing trade deals. In other words, we could see a resumption of the so-called "currency wars" of 2010-2014, where countries engage in a beggar-thy-neighbor competitive devaluation to boost their domestic economy at the expense of global prosperity.
Moving forward, we would not be surprised to see continued bearish jaw-boning of the world's reserve currency. If that fails to subdue the greenback, the Trump administration could increase pressure on Janet Yellen and the Fed to keep interest rates "lower for longer." While candidate Trump expressed mixed views regarding Federal Reserve policy on the campaign trail, he'd undoubtedly prefer continued easy monetary policy now that he's in office.
While the recent developments may have caught some bullish-dollar readers off guard, further weakness in the dollar would have one clear benefit: it would bring the time-tested inverse relationship between the greenback and stocks/commodities back into alignment.