Market continues to recoil from Trump intervention on currencies, rates
US President Donald Trump said the dollar is "getting too strong" and that he has offered China more favorable trade terms in exchange for helping nix the North Korean threat, sending the dollar and government bond yields shooting lower overnight and hitting several European stocks.
Attributing the strength in the greenback as being because “people have confidence in me”, Trump added that “there’s some very good things about a strong dollar, but usually speaking the best thing about it is that it sounds good… It’s very, very hard to compete when you have a strong dollar and other countries are devaluing their currency.”
However, the interview with the Wall Street Journal also revealed that, veering wildly away from his previous stance, he had told President Xi Jinping he was willing to accept a continued large trade deficit with China if Beijing could "solve the problem in North Korea".
Trump, who also rowed back on previous comments about China being a currency manipulator, also added “I do like a low-interest rate policy” from the US Federal Reserve.
Yields give way, gold gains
The combination of his comments sent the dollar sharply lower and saw US Treasury yields continue their fall, a day after the Fed Chair Janet Yellen announced that a "neutral" stance would be appropriate for US monetary policy.
Deutsche Bank's fixed income team noted that 10-year yields were hovering around 2.221% on Thursday morning, which was 8 basis points lower versus the level prior to the headlines hitting trader's screens, meaning 10-year yields were down over 16bps this week alone and about 40bps from March's highs.
Yields on euro zone bonds also fell as investors swarmed into high-rated German, Dutch and Finnish government bonds.
The overnight dollar sell-off and diving Gilts also dented stocks, namely the FTSE's and DAX's foreign earning contingents and bond-reliant life insurers.
But the dollar rebounded slightly on Thursday, having shot lower against a basket of currencies overnight, with the dollar index up 0.18% to 100.36 at 1230 BST.
Analyst Chris Beauchamp at IG said the interview marked a remarkable turnaround in a host of issues: "First we had the ‘Trump bump’, then the ‘Trump slump’, now we perhaps have a Trump volte-face?"
He added: "It is, of course, folly to try to work out policy from the president’s statements, but the shift to safe havens goes on, with low volumes ahead of a long weekend amplifying the moves."
Gold extended gains to $1,288, with Ipek Ozkardeskaya at LCG suggesting softer US yields could drive more capital into the yellow metal as the opportunity cost of being invested in non-interest bearing gold decreases. "The next stop for gold buyers could be $1,300. Support is eyed at $1,265."
Currency intervention
FXTM strategist Hussein Sayed said the US President has made many U-turns in his short time in office, but those on Wednesday evening were "of primary concern to currency traders".
During his campaign accused Fed Chair Janet Yellen of being “political” and “doing what Obama wants her to do” by keeping rates at zero, and even called the high equity prices a false market, with the cost of funds being essentially free.
"Now," observed Sayed, "he likes a low- interest rate policy and may reappoint Yellen to a new four-year term, possibly adding more doves to voting members.
"However, markets still believe that the Fed will continue with the tightening process for now, with June’s 25 basis points rate hike expectations hovering steady above 60% according to CME’s FedWatch. This is likely to limit further steep losses on the USD, but overall there’s a high chance that the dollar could have already topped out for the year."
Sayed added that backing away from labeling China a currency manipulator was seen as a positive development by markets, "as it eliminates the risk of China dumping its U.S. Treasury holdings and reduces the potential for further tensions between the world’s largest two economies".
Naeem Aslam at Think Market said that while sentiment in the markets was generally adverse on Thursday, traders were "more focused towards hedging their positions, than anything else", with the recent spike in the VIX index flagging that investors were taking advantage of cheap volatility index to hedge their risk.
Despite this, he suggested the path of least resistance for the dollar remains skewed towards the upside rather than the downside.
"The US labour market is strong, inflation is picking up and the size of the Fed balance sheet is massive. The Fed is utilising the correct strategy in bringing the interest rate back to normal as long as the economic data is not hiding something from them. Thus, the current pullback in the dollar could be an opportunity to get back in if you have missed the original opportunity. The short term support is at 97 for the dollar index and the resistance is at the 103 mark."
Treasury to examine currency effects
Strategists at Rabobank noted that Trump's change of heart comes just days before the US Treasury is expected to release its bi-annual currency report on “Foreign exchange policies of major trading partners of the United States”, which is essentially an assessment of the President’s planned or implemented policies and how the administration has handled countries such as China, Japan, Canada and Germany and thus, how trade relations are expected to pan out.
"Trump’s verbal intervention since being elected and the resultant reflation trade has been notable," said Rabobank's Richard McGuire, with the market ran since the election seeing yields rise and inflationary expectations gather pace.
"The Fed’s March rate hike and discussion as regards further normalisation of policy (including the unwinding of the Fed’s balance sheet) will serve to underpin the view that the economy is indeed on the mend, placing additional pressure on dollar strength.
"The difficulty for Mr trump on this front is that this all clearly runs counter to a weaker currency and offers him little room for accusing trade partners (particularly those in regions that are maintaining soft monetary policies of their own) that they are actively manipulating their currencies with a view to damaging the US economy for their own financial gain."