Despite the U.S. dollar strength over the past two weeks, the U.S. currency is surprisingly down from the peaks following the Trump election victory.
For those investing in the dollar via PowerShares DB USD Bull ETF (NYSEARCA:UUP) or Gold via SPDR Gold Trust ETF (NYSEARCA:GLD), or crude oil via ProShares Ultra Bloomberg Crude Oil ETF (NYSEARCA:UCO), the anemic dollar strength should be concerning given the number of pro-dollar headlines out the U.S. since the election.
Where are we since the election?
Despite a Fed hike, a surprise Trump victory, a massive rally in equities, improved market sentiment surrounding possible fiscal stimulus, tax cuts, deregulation - the 10-year Treasury yield rally from 1.77% and sitting atop 2.5% resulting in bank stocks surging like Bank of America (NYSE:BAC) by over 48% - the dollar is down by 2% since the January peak and only up 5% since the election.
Here are three reasons the dollar is being held back:
Fed perception in the market:
Despite the Fed hike in December and the promise of three hikes in 2017, the market is convinced the Fed will turn dovish at some point this year just as they did shortly before the March meeting of last year. It appears the Fed wants it both ways - sounding tough and sheepish at the same time. Here are two excerpts from the minutes of the December FOMC meeting:
This was later followed up by:
If Fed hikes fewer than three times this year and maintains their unwillingness to shrink the Fed balance (currently at $4.5 trillion), traders may begin selling into dollar rallies, in other words selling at the top of a move, with the hope of getting back in after the dollar bottoms out.
It's hard for investors to put their money in the market when they're not sure of when the Fed will hike or whether they'll hike two or three times this year. Despite the massive rise in U.S. bond yields from a percentage basis, the dollar has done very little which likely translates to market confusion and uncertainty.
Uncertainty surrounding President Trump policies:
This week, the president will address Congress to outline his plans and strategy for the next four years. In the past, the president has promised tax cuts and infrastructure spending.
Investors are weary of politicians making promises they later go back on. The president may be in for a shock and a political science lesson when he realizes that Congress typically moves at glacier's pace. The president is going to need Congress to get his policies passed, and no executive order is going to change how legislation in passed in the U.S.
If tax and fiscal spending policies take longer to implement than the market expects, the dollar will be hard-pressed to rise and may even weaken, particularly against the yen. The Japanese yen is considered a safe-haven currency and in times of uncertainty, investors often pour money into Japanese government bonds, this strengthening the yen.
U.S. GDP was weaker than expected coming in at 1.6% for the year according to the Bureau of Economic Analysis. Watch out for the next two revisions since it's quite possible that last year's growth rate may get revised upward.
If we get a replay of the anemic economic growth from early 2016, hopes of Fed hikes will fade and so will dollar rallies. We will need very strong growth on the back-end of this year if we start off slow again in 2017.
Going forward, watch for surprise GDP revisions to the upside. Durable goods orders (large item purchases) are a great leading indicator for GDP growth revisions and can move the dollar before the GDP release.
Also watch for inflation which has been on the rise. However, any inflation that's absent of economic growth will do little to alter the Fed's dovish leanings.
For those looking to get in the dollar trade, hopefully, it hasn't topped out. The economic fundamentals typically work in the dollar's favor - higher rates, yields, and growth - but currently, the murky fundamental picture is holding the dollar back.
It's been tough for investors to get in on the dollar trade lately since the fundamentals are not cooperating but hopefully, there'll be an opportunity in the next few months to get in.
Since markets don't move in a straight line but rather in ebbs and flows, at some point, there will be a pullback. At some point, Trump and Congress will disappoint the markets, the Fed will do less or say something contrary to market expectations, or geopolitical risks and risk aversion will percolate. And of course, at some point, there will be drama in Europe striking fear throughout the investing world.
All of these events have the ability to change the fundamental factors in the market, even if just for a moment. And a window of opportunity will open as the market retraces, settles and bottoms out, and we'll have our opportunity to get in.
More to follow on yields, financials, the dollar, and risk management techniques designed to prevent that dreaded "bad' trade. If you like this article and would like to read more of my market analysis, please click the follow button to the right of my name at the top of this article.
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.