Hold On To Your Dollars, There's A New Sheriff In Town

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As the line between politics and monetary policy disappears, FX markets will be parsing every word out of politicians' mouths.

The dollar is especially vulnerable to this dynamic.

Will Donald Trump look to commandeer FX markets?

Occasionally - and it's rare - I'll show some humility.

Don't believe me? Let me quote myself (and yes I'm aware of the irony in quoting oneself to prove how humble one is):

One of the peculiarities of writing about markets (or any other subject about which there's considerable debate), is that eventually it becomes impossible to determine whether you're inspiring like-minded people to investigate what you think is important, or whether you are in fact the one who was inspired by someone else.

More simply, the whole thing becomes an echo chamber in which phrases like "just as I said earlier this month" and "as I noted previously" reverberate ceaselessly and everyone frames everyone else's research as an extension of their own musings.

Those passages from a post out Friday suggest that I'm acutely aware of the possibility that my missives are not in fact prescient but rather, they just appear so when analysts repackage and rerelease previously published research that I at one time read and repackaged myself.

That is, if I read a piece of research and subsequently incorporate the ideas into my own thinking, I can't then call myself prescient if the person who wrote the original research decides later to revisit and reiterate their original thesis.

That's the echo chamber effect. But because I can't possibly keep a mental tab of all of the research I read, I naturally get excited when a new piece comes out that reinforces my own take on markets. At some point, I may have read something from the very same analyst whose new note I'm telling myself is confirmatory. In that case, it's not me that's prescient, but rather the analyst. Over the years, it becomes impossible to tell who said what first, so we all just say "see, I told you so," when someone else writes something that seems to backup our own work. That's not ideal and it smacks of confirmation bias, but alas, there's no way around it.

So with that long-winded caveat now firmly in the books, let me fall into the trap described above. Credit Suisse is out with a new piece that seems to confirm precisely what I said last week about the possibility that the line between politics and monetary policy is getting increasingly blurry. Here's what I said on Thursday:

To be sure, it's nothing new for markets to trade off policymaker soundbites. That said, I'm concerned that in the fog of uncertainty (Brexit worries, concerns around elections in Europe, the looming showdown between the Fed and the Trump administration over dollar strength, the Politburo's control over RMB policy, etc.) the divide between politics and monetary policy is disappearing. Indeed, political expediency may require that the two be merged. That could make it decidedly difficult for FX markets to determine who's ultimately in charge and whose comments should be given the most weight.

I then reiterated the same argument on Saturday morning. Have a look at the following chart which demonstrates the tug of war between politics and monetary policy when it comes to the FX markets:

"Will Donald Trump look to dictate monetary policy?," I asked, before answering my own question as follows:

The answer is 'probably'. After all, he's already dipped his toes into monetary policy once by criticizing Janet Yellen for keeping rates too low for too long. Never mind the fact that in the current environment, raising rates is entirely incompatible with his call for a weaker dollar (which Trump wants).

So given all of that, you can imagine how giddy I was to read the following from Credit Suisse (my highlights):

Inauguration will mark a shift in market focus from policy expectations to policy decisions and implementation. While the balance of expectations remains overall in favor of further USD strength, we note that some of the tail risks we first highlighted in [our 2017 Outlook] have become more prominent in the past three weeks.

Specifically, last weekend's comments by president-elect Trump referencing dollar valuation are an important development. Although it was mostly aimed at the USDCNY rate, the idea of US political intervention in FX markets introduces a new (inasmuch as it's not been seen since the 1980s) and unpredictable element for the market to absorb. Similarly, US Treasury Secretary Mnuchin in his Senate confirmation talks stated that "there may be times when the dollar is too strong," suggesting that the administration might not be completely averse to occasional verbal intervention. Moreover, with Trump transition team member Scaramucci also referencing USD valuation over the weekend, saying "we have to be careful about the rising currency," the quiet period on this front since the November 8 election that allowed persistent dollar strength seems to be at an end.

Clearly, I agree. But I think Credit Suisse leaves out one important aspect of this dynamic. Namely that Trump didn't intend to say anything consequential. That is, he moved markets as much as he did on Tuesday (see chart above) without even meaning to.

"I almost guarantee you Trump didn't mean to say anything that could be construed as a 'game changer,'" I said on Tuesday, adding that "he was just shooting from the hip." Bloomberg's Mark Cranfield agrees. "It was probably meant as a throw-away line, but it still roiled markets," Cranfield said on Friday.

That makes the situation even more precarious than Credit Suisse suggests.

First, Trump can and will move markets accidentally, creating all kinds of turmoil, especially if, upon realizing what he's done, he tries to reverse course and further confuses the headline-scanning algos prowling around the FX jungle.

Second, ask yourself this question: if Trump can send the dollar (NYSEARCA:UUP) plunging with a "throw-away" line, imagine what he could do if he set out to move markets on purpose.

If his inner circle gets in on the act and tries to jawbone the currency lower, things could get even more hectic.

So the moral of the story is: be careful with those dollar longs. There's a new sheriff in town and if he gets it in his head that the dollar should be lower, he might just decide to let us know about it. On that note, here's Credit Suisse with the last word:

We remain very wary of the potential FX implications of a protectionist shift in US trade policy, a risk that appears even more prominent in light of Commerce Secretary nominee Wilbur Ross's testimony to the Senate earlier this week. In particular, we view the statements that "Nafta is logically the first thing for the US to deal with" and that it will be addressed "very very early in the administration" as suggesting that the risk of an early repeal of Nafta is significant. Elevated front-end vol levels in USDCAD and USDMXN suggest that these issues are understood by markets, but the lack of a similar "kink" in the risk reversal skew curves suggests that markets might expect high realized volatility but without a clear directional bias.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.