US Dollar Peaking Against Western European Currencies: Soc Gen's Juckes

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Regardless of what president Trump announces in his tax reform speech today, the Dollar is probably peaking versus western European currencies, says Kit Juckes, a foreign exchange analyst with Société Générale.

Whilst cutting taxes might stimulate short-term rates and therefore the Dollar the effect is likely to be short-lived.

For Société Générale the future direction of US interest rates is where the Dollar story lies.

The debate about monetary policy has shifted from whether or not there will be a June rate hike to what the Fed Funds ‘terminal rate’ will be.

The terminal rate is the peak of the Fed Funds rate – or the US interest rate in common parlance – and SG’s Kit Juckes thinks this lies at around the 3.0% level, which by historical standards is quite low.

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More importantly, it is also below the terminal rate expected by the members of the Federal Reserve themselves based on the ‘dot plot’ showing their individual preferences for future rate levels.

The culprit for this situation is low inflation and the suggestion is it might stunt USD appreciation going forward.

Juckes uses the analysis to formulate a trade call to sell USD/SEK, based on a recovery in Swedish monetary policy from ultra-loose to progressively tighter.

“We issued a short USD/SEK trade recommendation yesterday on the view that we have seen the peak in the US dollar against Western European currencies, and the Swedish krona should benefit going forward as the monetary and valuation divergence against the dollar narrows,” says Juckes.

One spoiler to the view is if the President announced the introduction of an obviously pro-Dollar tax reform such as the imposition of a border tax of 20% on imports or an 'amnesty rate' on overseas repatriations – of which the latter would have the most bullish impact on the Dollar.

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Also calling the end of the rally in the US Dollar is analyst David Bloom at HSBC.

Bloom tells clients that for him the Dollar's long-run advance is likely to fade with President Donald Trump unlikely to achieve the kind of tax cuts required to extend the currency's advance.

For Bloom, the US faces eye-watering levels of debt and it is this, not any opposition party, that will keep his policy agenda on a sober path.

However, we have also noted that the month of May tends to be a good month for the broader US Dollar complex with past form suggesting there is a strong likelihood of the currency move higher.

“Economic momentum has the potential to shift to neutral from bearish for the Dollar in the coming weeks,” Meera Chandan at J.P. Morgan who flagged up the notion that the Dollar could appreciate in May based on past performances.

A slowdown in US economic activity has played a part and in recent Dollar performance. “There has been a seasonal element to this undershoot in recent years with US data typically softening in Q1 and then stabilising in Q2, which also translates to seasonality in the Dollar,” says Chandan.

The analyst notes the USD Trade Weighted Index has increased in May in each of the last five years by an average of 2.1% and seven out of the last ten years by an average of 1.0%.