In Davos, Mnuchin explained
A weak dollar wasn’t harebrained
It helps to upgrade
Both exports and trade
Thus for the US much is gained

The dollar is on the outs this morning with one key story the driver. Treasury Secretary Steve Mnuchin has basically moved away from the strong dollar mantra that had been official US policy for at least two decades by telling reporters the following, “Obviously a weaker dollar is good for us as it relates to trade and opportunities, but again, I think longer term the strength of the dollar is a reflection of the strength of the US economy and the fact that it is and will continue to be the primary currency in terms of the reserve currency.” Given the evolution of policies around the world lately, and the fact that President Trump has been consistent in his mercantilist philosophy of trade, the only surprise is the clarity with which he stated his case. After all, almost every major country seems to be seeking to weaken their currency in order to help their own trade situation, and these days as a way to import some inflation. However, comments have usually been about ‘excessive strength’ in a currency needing to be addressed, rather than a specific endorsement for a weaker currency. It appears ‘Beggar Thy Neighbor’ policies are coming back into the light.

This clearly changes a great deal in terms of short and medium term expectations, but do not be surprised if we see an increase in rhetoric about the strength of other currencies by other central banks and governments in the near future. However, for now, the dollar certainly has room to decline further after having made new three-year lows this morning.

In fairness, there was some pretty good data elsewhere as well, which helped underpin other currencies. For example, UK employment data showed a much larger than expected increase in the 3M/3M jobs numbers (exp -12K, actual +102K) and an uptick in average weekly earnings. The upshot is the pound has traded back to 1.4100, its highest point since the day before the Brexit vote in June 2016. While I continue to believe the BOE will be very reluctant to raise rates before the end of the Brexit process when the UK leaves the EU, my view is clearly in the minority with the market pricing in a 77% probability of another 25bp hike before the end of this year.

Turning to the Eurozone, PMI data was released showing modest underperformance in manufacturing but strength in services and in the composite numbers. In fact, we are looking at the strongest composite data here since the immediate aftermath of the financial crisis and ensuing recession, when the global economy was rebounding from a very low base. But for sustained growth, this is the best data for more than a decade. This has merely served to further support for the idea that the ECB is going to be ending QE this year. All eyes are turned to the ECB meeting tomorrow, although it would be quite surprising if Signor Draghi succumbed to the growing pressure to describe changes so soon. All told, however, the euro has rallied to its strongest point in more than three years and the trend remains for further strength.

Meanwhile, USDJPY has traded back below 110 for the first time since September despite Japanese trade data showing a less than expected increase to $3.2B in December. Given the importance of trade to the Japanese economy, currency strength is a much more critical issue, but also given the current US stance on its own trade deficits, I expect the Japanese will be loathe to raise too big a fuss.

The rest of the G10 has also benefitted, as have commodity prices and EMG currencies. In fact, there is nary a currency out there that has weakened vs. the dollar this morning. Ultimately, the question becomes how long can this go on in the face of increasingly tighter US monetary policy. As I have written before, it is clear the FX market believes that other central banks will be more aggressive than current interest rate futures are pricing while the Fed will be less aggressive. Despite the fact that US Treasury yields continue to edge higher, it has not been enough to stop the dollar’s decline. And at this point, it remains to be seen if anything will be able to do that. The next important data points in the US are Q4 GDP on Friday and then the PCE data on Monday, both leading into next Wednesday’s FOMC meeting. Remember, the Fed is entirely focused on Core PCE, which last printed at 1.5% and is forecast to tick up to 1.6%. If that data point is firmer than expected (something which I believe is quite possible) then it may serve to slow the dollar’s decline while pushing US rates higher. However, if it is benign, or softer than expected, look for the pressure on the dollar to continue.

This morning brings only Existing Home Sales data (exp 5.70M), which seems highly unlikely to impact the FX markets. There are no Fed speakers due, but beware of further comments from Davos, where Mnuchin will find himself with more microphones in front of him. Remember, too, President Trump will be speaking there on Friday and there can be no doubt he will discuss trade, and if the currency is mentioned, it will be in a weaker light. So for now, the dollar will remain under pressure with its only hope a Fed that feels forced to respond to faster than expected inflation. But until we see that type of inflation data, the dollar is unlikely to find much support.

Good luck
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