1. The Dollar is falling, shaking the conviction level of Dollar bulls. What is notable
about this fall is that it coincides with broadly stable nominal rate differentials
(Exhibit 1), in line with front-end market pricing for Fed hikes that is roughly
unchanged since the start of 2017, with about 125 bps priced through end-2019. As
we have emphasized (“Interest Differentials versus Oil as Drivers of Recent Dollar
Moves“, FX Views, November 27, 2016), rate differentials are by far the most
important driver of the Dollar, so this divergence is potentially alarming. This FX
Views examines why the Dollar is falling. Most hypotheses, like better global
growth or a US inflation overshoot, don’t explain why nominal and real rate
differentials are so stable, even as the currency has fallen. We believe the principal
reason for the divergence is “Dollar down” rhetoric from the new administration,
which we think highlights the constraints facing President Trump, rather than likely
outcomes. After all, a policy mix that combines fiscal stimulus and protectionism is
hard to reconcile with a weaker currency, even if that is what the new administration
wants. The last episode when USD diverged meaningfully below rate differentials
began a year ago, when market fears over a large RMB devaluation were building.
That episode lasted over six months, ending with the Nov. 8 election. The current
episode should be shorter, with a good run for US data – our expectation – the tie
breaker.