The US Dollar has strengthened significantly since the result of the US presidential election on 8 November 2016.
The Dollar Index - a measure of overall US Dollar strength based on the performance of selection of key USD currency pairs - has risen from a November low of 95.94 to a January peak of 103.80.
The Dollar has since eased back towards the 101-102 region and questions are naturally being asked as to whether this is as good as it gets for the USD.
"With every tick lower in the U.S. dollar, investors are wondering if the greenback has peaked. After a tremendous rally in 2016, the mighty buck has struggled to extend its gains and is fumbling hard at the start of this new trading week," as professional trader Kathy Lien at BK Asset Management in New York.
Analysts at HSBC Bank plc have however taken a look at the Dollar, and they believe this trend is one that has legs.
“We believe that this move has momentum and the USD is likely to strengthen further,” says Mark McDonald, Head of FX Quantitative Strategy at HSBC.
HSBC have investigated systematic momentum strategies in the G10 FX space to try and establish if the current trend of USD appreciation is one that has the momentum to drive further substantial gains.
Having observed two trend models McDonald and his team, “find that when these strategies are used with USD-G10 pairs they deliver positive long-term results almost irrespective of the way in which momentum is defined or how the model is parameterised.”
Further, “the USD exhibits this powerful momentum in a way that other G10 currencies do not.”
In short, the US Dollar is one of the most reliable financial assets to back when for those looking to profit on trends.
“The reason why momentum strategies work so much better for USD-based pairs is that when the USD is trending, it really moves and it does so in a broad-based way. We believe that we are in this environment at the moment,” says McDonald.
When the USD Trends, it Trends
In a note to clients, McDonald emphasises the point that his team are not saying that only USD-based exchange rates experience trends:
“Exchange rates which do not contain the USD clearly do sometimes undergo large trends. However, whilst this is important, it is not enough by itself to generate a profitable trading strategy.”
“When prices trend for a sustained period, systematic momentum models will generate large profits. However, this happens infrequently so the key to successfully implementing a systematic momentum strategy is making sure that these large, but infrequent, profits outweigh the frequent small losses which come from false momentum signals,” says McDonald.
HSBC’s results suggest that it is far more fruitful to apply momentum strategies to USD-based pairs than non-USD pairs.
Don’t Stand in Front of the Trump Train
Backing the Dollar trend higher is the fundamental fuel that is the Donald Trump era.
HSBC believe that if Trump implements only a small fraction of the policies he proposed during his campaign we are likely to see significant dislocations between the prospects for the US economy and the rest of the world.
As mentioned already, since the election of Trump we have already seen a sharp strengthening of the USD and HSBC believe that this trend will continue for several months.
“The recent USD strength is based on a belief in the ability of President-elect Trump to institute structural changes. Even if you expect that this effort will ultimately fail, we would not recommend trying to stand in front of the Trump Train at this time,” says McDonald.
Indeed, predictions of a stronger Dollar are commonplace amongst the institutional research community at present.
"We see USD strength on the back of expectations of an improved US medium term growth. Positive productivity outlook on the back of expectations of a targeted fiscal infrastructure package, changes in the regulatory environment and tax reforms (i.e. lower taxes) under the Trump administration could lend support to the greenback," says Saktiandi Supaat at Maybank in Singpapore.
Trump's proposed fiscal boosts could lead to concerns of faster inflationary pressures and as such affect the Fed rate hike trajectory.
"In other words, there will still be some policy uncertainty for the most part of 2017. In 1H 2017, we expect on average a steepening of the UST curve with the back end rising faster than the front end (higher nominal rates)," says Supaat.
Maybank believe rising growth, fiscal boosts, higher yields should lead to broad USD strength as we move into the new year, notwithstanding potential lags in fiscal policy loosening and immigration curbs, residual slack in labour market and disinflationary impact of higher US yields and a stronger Dollar that could temper the Fed hawks.