No hope for a lasting USD rally

Outlook:

We get the PPI today, not a feeder to CPI but of general interest anyway as a guide to inflation. Tomorrow's CPI is of more interest, even though the Fed looks at the PCE version. Many analysts try to deduce inflation from yields or other market data, which we say is dan-gerous because many factors are behind purchases and sales of fixed income assets beyond inflation. Still, it's a truism that if inflation is actually on the rise, yields must follow—and equity valuations get rejiggered, too.

We are not getting any clues from the Atlanta Fed GDPNow report issued yesterday, the same 2.8% for Q4 as in the report on Jan 5. Net exports and inventory adjustments were marginally better.

What we can deduce from yesterday's price action is that risk appetite is falling now that the threat of a Trumpian trade war is out in the open. The WSJ reports there is talk that Trump may use his State of the Union address to Congress on 30 Jan. to announce an ‘aggressive' crackdown on China's unfair trade practices, including putting tariffs on imports of Chinese steel, aluminum and solar panels.

Immediately before the State of the Union speech, Nafta talks start up again. Yesterday we reported that Canada is trying mightily to stave off Trump ending Nafta aribitrarily and hoping "facts will win the day." Alas, there is not a soul who knows for sure what Trump will say or do, on China or on Nafta. He himself doesn't know right now and may not know until he begins speaking.

We write above that the China story is bunk from beginning to end. First, China has cut purchases be-fore with no fanfare, as well as stating it was diversifying reserves. If China really wanted to affect the FX market, the last thing it would do is announce it. If someone in China really did leak this story to gauge the reaction, it would have been a preemptive strike against Trump moving on from Nafta to China. Okay, maybe, but starting such a rumor would be uncharacteristically reckless.

And yet, we must appreciate that China plays a long game and has all the possible strategies worked out in advance. China knows perfectly well that a trade war is a big, fat dollar negative—and who is one of the biggest holders of dollars? China is not going to cut off its nose to spite its face, but when swords get drawn, it has some sharp ones.

Canada and Mexico are not without weapons, either, including bilateral trade agreements with the EU, Japan and China. Trump could end up being the inspiration for a giant Chinese investment in Mexico, say, a little far from the Silk Road but revenge is a dish best eaten cold.

We see no hope for a lasting dollar rally. Inflation tomorrow is not going to do the trick and the loom-ing Trump trade madness is an authentic drag.

Here is an editorial from Bloomberg that makes the point: "I've always been fascinated by the Swiss National Bank. It likely made a $55 billion profit last year, in part due to its equity holdings such as Apple, which had an awesome year. Of course, it's pretty weird for a major central bank to own shares like this. But then again, the SNB does a lot of unconventional stuff, like when it stunned markets by dissolving the currency's floor against the euro without warning, or when it sank rates deep into nega-tive territory.

"If someone was describing a central bank to you, and you were told it was trying to peg its exchange rate and it was printing money to buy stuff like Apple, while imposing negative rates, you'd think it was a joke operation and that the currency would be in the toilet. Yet the Swiss franc remains one of the world's strongest currencies. To me that says, all the stuff we classically focus on with respect to ex-change rates and central banking are overrated. What really matters: political and financial stability, which Switzerland has in spades. In a way, you can think of the country as having more stability and institutional strength than it needs or knows what to do with, and so when it prints money to buy shares like Apple, it is essentially monetizing that excess."

Now connect the dots to the US. If what really matters is political and financial stability, and if Trump endangers both in the US, what happens to the dollar?

 


 

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