One of the areas where President Trump has broken with convention is currency policy. The Trump administration’s unconventional and active use of currency policy, both in terms of rhetoric and practice, is a break from the established tradition of a laissez-faire dollar policy and a constructive-engagement-based approach toward currency manipulation issues.
This past week, the U.S. Treasury labeled Switzerland and Vietnam as currency manipulators. Additionally, the U.S. Treasury added Taiwan, Thailand and India to its watch list. With a little over a month left in the Trump presidency, it will be up to the next Treasury secretary to decide whether to keep or remove the currency manipulator label. In order to understand what to expect from the incoming administration, let’s take a look at how the U.S. has conventionally handled currency policy and the people who should be in decision-making roles. For those readers interested in our Year Ahead currency outlook, it can be found by clicking here.
The nomination of Former Fed Chair Janet Yellen as Joe Biden’s Treasury secretary increases the likelihood of U.S. currency policy reverting back to many pre-Trump conventions. If “people are policy,” then the U.S. will likely have a high bar to both express and implement an active dollar policy and will also likely take a cautious approach to accusing trade partners of currency manipulation. These conclusions are informed by an in-depth conversation that Yellen had at the Brookings Institution in 2019. During this conversation, Yellen expressed the view that currency moves are more often the result of macro or policy phenomena rather than deliberate manipulation. Further, Yellen touched on her time at the Fed and the accusations leveled against the central bank regarding the dollar-depreciating impact of quantitative easing.
Regarding the U.S. dollar, this likely means a return to the U.S.’s historical laissez-faire foreign exchange policy with dollar policy statements reserved for the Treasury secretary with statements limited to reaffirming the U.S.’s “strong dollar” policy. This “strong dollar” policy is seen as laissez-faire or “benign neglect” because it results from the view that currency valuation is largely endogenous and is difficult—if not impossible—to manage.
Yellen is also likely to make a push for the Treasury’s semiannual report to return to its role as a rigorously objective macroeconomic assessment exercise for which the hurdle to name a manipulator has been historically high and for which the remedy is measured and slow moving. But to be clear, this isn’t to argue that Yellen will be easy on a trade partner if it is found to have met the formal criteria for currency manipulation. Further, a return to a more orthodox macroeconomic basis for currency policy doesn’t mean that U.S. geopolitical pressure against currency manipulation will diminish because the Democratic Party platform strongly opposes currency manipulation as a form of unfair trade practice that harms U.S. workers. It is simply the expectation that recently introduced political factors are likely to be eliminated.
1- to 2-week view: Overall, the single currency continues to hold on to recent gains as global reflation and the EU’s approval of its budget and rescue fund support risk sentiment. To this end, industrial production numbers out last week beat expectations. However, many of the recent positive data points in Europe came before the recent lockdowns were imposed. The market’s bias toward optimism on global growth should keep the euro supported but lingering uncertainties should see the market cautiously building long positions on what could be a very choppy and volatile end of year that likely stays in recent ranges.
3- to 6-month view: The euro’s performance in 2020 was mainly driven by factors other than European economic performance. With the factors that pushed the euro higher in 2020 having faded or starting to fade, gains in 2021 should be harder to come by. Near-term optimism on a recovery in global growth helps the euro higher, but the single currency should dip into year-end as U.S. yields rise, the European Central Bank (ECB) continues to fight deflation and market focus shifts to questionable domestic growth fundamentals. In essence, it is difficult to see a sustained euro rally without European economic exceptionalism and the prospects of ECB rate hikes.
1- to 2-week view: The British pound price action should be volatile as it remains tied to Brexit negotiations. While this “will they/won’t they” drama has worn thin, multiple extensions indicate that both sides want a deal. As such, a skinny deal remains the base case, but the distribution of outcomes for sterling skews to the downside. Should there be a no-deal outcome, expect GBP/USD to drop to the mid- to low 1.20s in the interbank market. Conversely, a deal should see a relief rally taking the pound higher. On the virus front, London moved to level 3 lockdown, the highest level, on concerns of a “new variant” of the virus.
3- to 6-month view: The path for the pound in 2021 will depend on the interaction between the realities of Brexit and the speed and extent with which the U.K. economy can recovery from the pandemic. On the pandemic, the U.K. economy’s underperformance arguably makes it one of the biggest beneficiaries of a vaccine. However, Brexit drags to growth and massive fiscal deficits represent counterarguments. Market are assuming a skinny deal. While this is better than a no-deal exit, a skinny deal still represents a negative economic outcome relative to the status quo. This is why the pound is expected to drift lower after the initial relief rally as markets refocus on the fact that a skinny deal is still a fundamentally bad development.
1- to 2-week view: The core view is to add on rallies as expectations remain for USD/JPY to continue strengthen due to Japan’s real interest rate advantage, a pullback in outbound investment flows and stalled U.S. stimulus talks. This past week saw the Bank of Japan announce a surprise policy review, with fine-tuning to its ETF purchases likely, as national consumer price index fell more negative than expected. On the U.S. dollar side, optimism around a global growth and the Fed reiterating that it would continue asset purchases until “substantial progress” was made on the Fed’s dual mandate should continue to pressure the dollar and lend another factor biasing USD/JPY lower.
3- to 6-month view: 2021 should bring trend yen strength as a real yield advantage and inflation spreads remain in the yen’s favor. While the Japanese economy should benefit from Asia’s relatively low COVID-19 infection rates, a persistent negative output gap means a lack of inflationary pressures. As a result, real yield spreads and relative U.S.-Japan inflation expectations support yen strength, as does a drop in outbound investments. The increasingly crowded low-yielding currency club has reduced the yen’s role as a funding currency, and the yen’s cheap valuation has deterred yen shorts.
1- to 2-week view: The Canadian dollar continues to find support from the market’s positive outlook on global growth due to its cyclical nature and the firming up of oil prices. Unusually for the Bank of Canada, the central bank governor noted concern on foreign exchange strength, saying that the Canadian dollar was on their “radar screen.” Overall, the bias remains for CAD appreciation as the economy has bounced back stronger than expected. However, given the magnitude of the recent move and proximity to year-end, markets could be hesitant to initiate new risk positions.
3- to 6-month view: The loonie should continue to be driven by market sentiment. The CAD’s underperformance relative to its peers in 2020 reflects the currency’s ties to oil. For 2021, a global recovery should support a rebound in oil prices and the CAD. As such, the expectation is for the CAD to continue to strengthen as positive vaccine developments support broader risk sentiment and the ongoing global rebound. On the monetary front, the Bank of Canada and the Fed are unlikely to be major factors in the exchange rate, as policy actions out of both banks have been very similar.
1- to 2-week view: Growth indicators continue to point to a continued recovery in the Chinese economy. Relative economic outperformance, a current account surplus and relatively high yields form the basis for a bullish view and support a continued drift lower for USD/CNY. Expect China’s economy to carry strong momentum into early 2021, but in the near term, holiday malaise and ongoing U.S.-China tensions make it unlikely we will see substantial yuan strength between now and year-end.
3- to 6-month view: Based on China’s GDP growth outperformance, effective COVID-19 suppression, relatively higher interest rates and portfolio inflows, the yuan should continue to add to gains. Tail risks to this narrative come through trade policy. Given this, the Biden administration should reduce tensions and rhetoric and pursue a more deliberate trade policy. Regarding the monetary front, the People’s Bank of China is unlikely to push heavily against further currency appreciation, due to the desire for greater yuan internationalization and two-way flexibility in exchange rates. CNY gains could potentially turn to consolidation at the end of 2021 as China’s relative growth outperformance slows and the tourism deficit starts to rise again.
1- to 2-week view: Vaccine optimism, blockbuster domestic economic data and the continued rally in iron-ore have helped the Australian dollar move higher despite continued tensions with China. However, this past week saw China imposing a ban on coal, which is a significant step up from prior actions, and Australia fighting a new COVID-19 outbreak. Overall, there is little to add that hasn’t already been written, especially with holiday malaise about to take hold. The U.S. dollar continues to be pressured as global sentiment remains positive, so the AUD should continue to find support from a weak dollar and growing economic optimism that should lead to a pullback in the Reserve Bank of Australia’s (RBA) dovish rhetoric. However, one also has to acknowledge that current levels are unattractive, so expect markets to wait for dips before adding new AUD longs.
3- to 6-month view: Near-term price action has been driven more by the currency’s correlation with global equity markets than with domestic factors. Once we are past the pandemic and risk assets start to normalize, the relationship between the AUD and the stock market should fade and give relative monetary policy increased significance. This is important as the RBA has committed to catching up with other central banks, ensuring relative accommodation. The RBA’s commitment and capacity to expand relative asset purchases should see the currency lower.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
No Major Central Bank Meetings
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
U.S. Consumer Confidence
Expectations for a 97.0 print
U.S. Durable Goods
Expectations for a 0.6% increase
U.S. Initial Jobless Claims
Expectations for a 863,000 print
Canadian Oct. GDP
Expectations for a 0.2% month-over-month increase
EZ Consumer Confidence
Expectations for a -17.3 print
German Consumer Confidence
Expectations for a -7.7 print
Asia/Japan, and New Zealand
Japanese National CPI
Expectations for a 0.8% year-over-year decline
Japanese Unemployment Rate
Expectations for the rate to remain unchanged at 3.1%
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