How have currencies performed since Trump's election?
US bull market anatomy
Since Trump's election in November, financial markets have focused on the reflation trade. Inflation expectations and bond yields have risen, as have equities and commodities. Although the US dollar has strengthened by a little over 3% on a trade-weighted basis, this masks the individual currency winners and losers.
The Federal Reserve has helped the reflation narrative by hiking rates in December, while (realised) inflation continues to be on its steady ascent. Of course, both the Fed and the recent monthly inflation prints may not have been influenced much by Trump's election, but when building an investment narrative, that's not always a key consideration.
The reflation story is supported by some of Trump's campaign pledges (see Tim's 'phenomenal' blog). Increased fiscal spending and lower individual and corporate taxes helps. Let's call this 'Good Trump'. A new repatriation act allowing US firms to bring back retained earnings from abroad at a favourable tax rate also falls into this camp. But is there a 'Bad Trump' as well? Absolutely; any protectionist measures like slapping tariffs on (some) imports, or more widely through a border tax adjustment, could hamper both global trade and global growth, while being inflationary for the US.
Interestingly, 'good Trump' and 'bad Trump' are both perceived to be supportive for the US dollar. We agree with this notion as long as the Fed plays ball and reacts to higher inflation (expectations) by raising rates. However, the US dollar is unlikely to strengthen in a straight line. The market could overreact at times, and long positioning in the US dollar may get overstretched. This could explain the partial reversal in the US dollar that we saw in January.
Looking at the US dollar alone masks winners and losers on the other side of the trade, as exchange rates have to be relative to another currency. To analyse the anatomy of the US dollar bull market, we need to look at the performance of the main currencies versus the US dollar since the American presidential election.
In a strong US dollar environment, of course, most currencies will depreciate against the dollar. However, we are interested in which currencies have done better than what might have been expected from history (in this case the past five years), and which currencies have done worse, as shown below.
Looking at developed currencies, only the Japanese yen has been exceptionally weak, while the euro has weakened in line with its historical norm. Other developed currencies have performed better. The weakness in the yen mirrors its strength seen earlier in 2016, but it also reflects the dependency of monetary policy in Japan on US interest rates. The Bank of Japan is targeting 10-year Japanese yields of close to zero. This probably implies expanding its balance sheet when global yields rise (yields which in turn are heavily influenced by US rates).
In Asia the picture is quite mixed. Despite the threat of the US labelling China a currency manipulator, the Chinese yuan has behaved normally. Other Asian currencies used as a proxy for the Chinese yuan, such as the Korean won, the Taiwanese dollar and Singapore dollar, have done somewhat better.
Latin American currencies have actually strengthened versus the US dollar, despite the norm being weakness in a strong US dollar environment. The big exception is the Mexican peso. Trump has made Mexico a primary target, threatening to build a wall at the US-Mexico border and to slap a tariff on Mexican imports. The peso had already fallen before the election, but this didn't stop another rout when Trump was elected. Since his election we have been positive on the Mexican peso on valuation grounds, believing that currency markets priced in a too bleak picture for Mexico.
Trump's stated desire for better US relations with Russia, possibly resulting in an easing of sanctions on Russia, can be seen in the performance of the Russian ruble. The ruble has been the strongest currency, rallying almost 10% against the US dollar since the US election. We have been positive on the Russian ruble for much longer amid an improving macro backdrop and a healthy carry (see one of my earlier blogs).
We believe that the weak performance of the Turkish lira and the strong performance in the Israeli shekel and South African rand compared to their respective norms has less to do with the US dollar and more to do with local developments in Turkey, Israel and South Africa.
We remain broadly positive on the outlook for the US dollar, but it's important to remember that markets don't typically move in a straight line and tend to offer plenty of tactical opportunities.