Against the tide: The return of the euro?
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Against the tide: The return of the euro?

The dollar’s multi-year bull run might last a couple more months, but its fundamental underpinnings are weakening.

euro dollar rolls-600

President Donald Trump’s unpredictability accounts for a lot and I don’t think that US protectionist measures – tariffs or some form of border tax – would be good for the US dollar.

Sure, they ‘improve’ the US trade account and would heft inflation. So the Fed must tighten more, but Fed tightening (more than other central banks) is a tired story – even if the market still lags the dots.

Protectionism might hurt the US capital account more than it helps the US trade account.

On the capital account, there is risk of damage to the US dollar from second-order effects – principally retaliation by China, which could include reducing its $1 trillion holdings of US treasuries or a myriad of anti-US corporate measures in China. And that’s before confrontation about the South China Sea kicks in.

Then there’s the euro. The European Central Bank (ECB) is done easing. The ECB targets headline inflation adjusted for transient effects. Headline CPI is likely to end the year closer to the ECB’s 2% target than anyone thinks.


As important, the Germans want no more of this quantitative-easing thing for a good reason: their inflation rates are ramping up. Indeed, Germany headline inflation was at its highest in 41 months in December and core hit a 20-month high. The European economy is doing fine and the German economy is on fire.

The domino theory of populism might be about to fail the reality test too. Italy dodged a banking crisis bullet and a failed referendum almost unscathed. And the constitutional court has ruled out a referendum on most of Matteo Renzi’s labour market reforms. It also seems early elections are less likely after the court ruled out some aspects of the electoral reform law (Italicum).

No party is close to gaining 40% of the popular vote, so this effectively consigns Italy to more weak government. And this ruling has made it harder for the populist Five Star Movement to get to power. Given that the economy is also doing a bit better, the decision plays vaguely into the hands of the government and might even provide Renzi with a platform to get his job back.

France looks likely to give the populists (Front National) a bloody nose. Marine Le Pen could even fail to make the second round of the presidential election, which could well turn out to be the classic run-off between the traditional right and left.

In Germany, whether a Martin Schultz-SPD-led coalition wins or Angela Merkel serves another term as chancellor after the federal election in the autumn, the government will remain pro-EU and pro-euro.

In the Netherlands, Geert Wilders’ far-right (PVV) might become the largest party this month, but it will still fall well short of the number of seats to get a majority in parliament. And none of the other 11 or so parties that will end up in the legislature will have anything to do with them.

Beyond 2017

So beyond 2017, the populist shoe will have failed to fall in Europe – at least for a while. Together with an EU economy doing better and an ECB done with easing, that could change perceptions of the euro a lot.

The market effect would be amplified if this coincided with Trump damaging the dollar in the global arena, or failing to deliver fiscally all the good news anticipated by US equity investors.

All that would matter less if the US dollar were cheap. But it is not. Sure, there are things out there which could push it to a greater extreme – such as profit repatriation. The flow effect of this is largely psychological, given that most ‘profits’ retained are already denominated in dollars.

Where the risk is real is for equities, because the proceeds will be used for buybacks and M&A, so altering supply and demand. There could also be a knee-jerk reaction in the dollar to protectionism or a border tax.

But the US administration doesn’t want a super-strong currency and might act to prevent it. And given the maverick nature of Trump, he is as likely to act in ways that weaken the currency rather than strengthen it.

And, of course, the president’s antagonistic and unpredictable foreign policy agenda has the potential to make the US look much less of a safe haven for capital flows.

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