Imagine if, at the start of the week, I had told you the following: Top-tier U.S. data would be unanimously strong, with solid readings on inflation (CPI and PPI), retail sales, and a 30-year high in the Philly Fed Manufacturing index.
After focusing his early efforts on controversial immigration and trade measures, President Trump would pivot to emphasizing fiscal stimulus, including the imminent announcement of a "phenomenal" tax reform plan.
Fed Chair Janet Yellen would be surprisingly hawkish in her semi-annual testimony, noting that it was "unwise to wait too long" to raise interest rates...and that the market-implied odds of a March rate hike would correspondingly rise by 10%
You would probably expect the U.S. dollar to be trading substantially higher on the week, wouldn't you? I know I would!
Instead, the world's reserve currency has been mixed, edging higher against the commodity currencies and pound, essentially unchanged against the euro and Swiss franc, and actually losing ground against the yen. Indeed, the dichotomy between ostensibly strong U.S. data and a weak U.S. dollar stretches back to the start of the year; since New Year's Day, the greenback is actually the worst performing major currency!
...So what gives?
As with most market moves, there are multiple explanations for the dollar's weakness so far in 2017. One of the most straightforward, in our view, is that the "long dollar" trade was simply too crowded at the start of the year. According to the CFTC's Commitment of trader data, "Large Speculators" were net long nearly 50,000 contracts on the dollar index, an historically elevated figure. In some ways, everyone that could reasonably be expected to buy the US dollar already had.
The other primary reason for the recent dollar underperformance has been the market's wariness toward Trump's policies. As we've outlined before (see "Trump Administration sacrifices the dollar on the bullish equity and commodity altar" for more), a strong dollar is a direct headwind to the administration's other goals, namely boosting domestic growth and stoking a manufacturing renaissance. Unlike the previous laissez-faire government policies of the last several decades, the Trump Administration has implied that it's willing to "jawbone" the U.S. dollar lower or engage in outright protectionism to drive the currency down.
Will Trump and company resort to these extreme measures? It's hard to say at this point, but any hints of this type of action could immediately hit the greenback, regardless of what the Fed or economic data says. We've hit repeatedly on this topic over the last couple of months, but it's arguably the most important dynamic for forex traders to watch in the first half of the year.
Keep an eye out!