The Dollar Might Surprise in 2017

January 25 2017

Parity. We hear and read about parity almost everywhere, especially when you talk to an analyst or read a report with this year´s EUR/USD forecasts. Analyst after analyst predicts or prepares for a scenario in which the EUR/USD exchange rate drops to 1.00 or even lower over the course of the year. And the analysts that have a different outlook, expect the EUR/USD to remain at more or less the same level. Forecasts of a rising EUR/USD exchange rate are rare.

One of the most important reasons to expect a further decline to parity, is the strong belief that the Fed will continue its interest rate hikes and raise the official rate three times this year. Not only because the Fed itself sort of announced all this in December last year, but also because the new U.S. president has said loud and clear that he considers the current Fed monetary policy to be bad for the country and that he advocates higher interest rates.

In an earlier article, I wrote that we should not forget the statements Trump made during the U.S. presidential campaign. During an election, campaign candidates often say whatever suits them, which then turns out to be completely worthless after the election. I wrote: “Now that Trump has won the election, I ask myself whether he would be still as happy as before with a series of rate hikes. His plans for extensive investment in infrastructure would turn out to be more expensive and the interest burden of the U.S. government would increase heavily and as a result there would be no money left for all the other well intentioned economic policies of Trump.” At the time this was only an educated guess, a suspicion if you like. Since last week this is no longer the case.

Unwritten Rule in the Trash Can

The tough monetary discourse of Trump led to a substantially lower EUR/USD in recent weeks. But even before he moved into the White House, Trump already changed his mind.

In an interview in the Wall Street Journal, the new U.S. president said that the dollar is too strong and that the dollar should be a bit weaker. American companies are, as a result, not able to compete with foreign companies, according to Trump, and that is a bad development for the economic growth in the U.S., especially in a period in which the president already declared multiple times that he would bring about high economic growth.

What might we deduce from all this? A few things in my opinion. In the first place, that the Federal Open Market Committee (FOMC) of the Fed is not going to take a radically different course when president Trump in a few months will appoint new members to the board and at the end of the year even has the chance to appoint a new chairman.

Something else we might expect is increased uncertainty regarding the dollar. After all, the unwritten rule abided by every American president was that he either would never say anything about the dollar or, in case he would do so sporadically, would repeat time after time the same phrase, “a strong dollar is in the interest of the U.S.” Nevertheless, now we will have a president who is not only deterred by speaking publicly about the dollar, but does so without any subtlety and without any respect for the earlier mentioned unwritten rule.

Investors that must assess the value of the dollar in 2017 should therefore not only take into account whatever the Fed says and does, but also what president Trump will say. With his image of someone who resorts to unfounded and bold statements, this means that an already tough task is about to get even tougher. And that, subsequently, increases the probability of higher EUR/USD volatility and might even lead to large shocks in the exchange rate.

And what about that parity? I would not be surprised if EUR/USD, against all expectations, will appreciate substantially in the course of this year. A weak dollar benefits precious metals prices to a greater extent than a strong dollar. This holds especially true in conditions in which many anticipate a much stronger dollar. 

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