Thought of the day
19.07 - The dollar and Trump
The abrupt end to the latest Trumpcare reform bill this week did not materially damage US stocks, with minimal impact on the S&P (-0.1%), and its insurance (-0.2%) and healthcare (+0.1%) sub-indices. This suggests that President Trump’s promised tax cuts and infrastructure spending appear largely priced out of equities.
But the same can’t be said for the foreign exchange markets, judging from the 0.55% fall in the US dollar Index following this latest Trump agenda setback. Most major crosses rallied against the dollar on the news, with EURUSD rising as much as 0.7% to test a 14-month high of 1.158, bringing the market closer to our long-held dollar skeptic views. We think the dollar has further room to fall:
- Donald Trump’s troubles appear to be worsening, with the constant drip of Russia-related scandal intensifying, further distracting both the Republican party and the White House from the pro-growth agenda and calling into question their ability to pass important reforms.
- The outlook for further Fed tightening took a hit from slightly more dovish messaging this month, with Janet Yellen hinting subdued inflation could feed into the pace of rate hikes. While we continue to expect another 25 basis-point hike this year, the Fed will likely stay on hold if core PCE inflation does not pick up from the May reading of 1.4%, down from 1.8% in January.
- The dollar remains fundamentally overvalued, in our view, and reliant on foreign flows from (arguably) less politically pessimistic international investors. On a purchasing power parity basis alone, EURUSD should be nearly 10% stronger at 1.26.
So we continue to prefer the euro over the US dollar, and maintain a six-month EURUSD target of 1.18 and a 12-month target of 1.2