Dollar - Real Progress or False Promises?

The US dollar enjoyed strong gains in the first week of February, but even a budget deal in Washington failed to drive it higher. With retail sales falling by the biggest amount in nearly a decade, many forex traders are wondering if the US dollar is past its prime. Last week all of the major currencies held steady or traded higher against the greenback. The New Zealand dollar rose the most on the back of the Reserve Bank's monetary policy announcement. The Australian dollar was not far behind in gains but the Japanese Yen, Swiss Franc and euro lagged behind. A large part of these moves were drive by progression in US-China trade talks and its positive impact on risk appetite. The Dow Jones Industrial Average ended the week at year to date highs and further gains are likely if the US officially extends the March 1st trade deal deadline. With no monetary policy announcements or major US economic reports on next week's calendar, softer consumer spending will linger on everyone's minds.

However we've been down this road before. President Trump says US-China trade talks are going well, the market believes him and rallies in the hopes that tariffs will be delayed, reduced or eliminated. Days or weeks later,  the White House says there's too much division to reach an agreement at this time. The US, Australian and New Zealand dollars soared on the hope that with the March 1st deadline 2 weeks away, Trump's comment that trade talks are "going well" is a sign of real progress and not false promises. Trump said he's open to extending the deadline and could even remove the tariffs if a deal is done but until an agreement is signed, sealed and delivered attitudes could change quickly. What is certain is that another government shutdown is no longer a concern. Even though Trump's decision to declare a state of emergency to get wall funding opens up new legal and legislative problems, for now, hundreds of thousands of federal workers won't have to worry about missing pay checks again. And by returning to work, they provide much needed underlying support for the economy because if retail sales dropped by its largest amount in nearly a decade before the shutdown, the January numbers could be much worse.

The problem for the dollar is that economy is slowing and we are finally beginning to see the evidence. Not every one of this past week's economic reports surprised to the downside, but the two most important measures for the Fed - inflation and spending missed expectations. So fundamentally, the dollar shouldn't be that strong especially since rate hike expectations have pared significantly since the last meeting. However if a trade deal is reached between the US and China, or China gets an extension, the market's appetite for risk will return taking the dollar higher against the Japanese Yen. There is a very good chance that the March 1st deadline will be pushed out so the slide in USD/JPY will be limited but there's still significant upside for the Australian and New Zealand dollars. Until that happens though, the softer retail sales report will continue to haunt the greenback especially as this week's FOMC minutes remind investors that the central bank has no plans to raise interest rates soon.