What a difference a couple of weeks makes. Throughout December, the U.S. dollar (NYSEARCA:UUP) strengthened considerably, leading to the U.S. dollar index hitting a 14-year high of $103.82. But fast forward to today and the index has slumped to a 5-week low and now fetches just $101.50. Furthermore, bond yields have narrowed and the gold price (NYSEARCA:GLD) has risen.
Sourced from DailyFX
What has been the cause of the slump?
Surprisingly all this appears to have happened not because of what has been said, but rather what hasn't been said by president-elect Donald Trump. Whilst the underwhelming job data released last week also played a role, we feel a lot of selling pressure came when Trump failed to offer any clarity on his fiscal promises. Rather disappointingly, in a speech dominated by "fake news" accusations, Trump didn't just fail to add clarity, he made no mention of the fiscal plans he will put in place once he takes office.
With the market, and even the Fed, speculating that Trump's policies would reignite inflation and lead to faster economic growth, the lack of a plan appears to have left traders concerned that this could be another policy he backs down from, in a similar way to how he has readjusted his stance on who will pay for the Mexican wall. Although we expect inflation to continue to rise steadily without his policies, it almost certainly wouldn't rise as quickly as previously expected. This could limit the number of rate hikes the Fed can deliver in 2017.
Why didn't he clarify his policies?
Well if there's one thing to expect with Mr. Trump, it is the unexpected. This is something we will all have to get used to. But just because he didn't clarify his policies in this latest press conference, doesn't mean they aren't coming. Whilst it would be great to understand the size, mix, and timing of any fiscal easing right away, we think traders need to be patient with this sort of thing.
We would much rather the Trump team spent time coming up with a plan that fits, rather than rush into things to satisfy the market. We feel reasonably confident that Trump will run the country like it is a business. Because of this we expect the tax cut and infrastructure promises he has made will be delivered, as they really are the only option he has.
So what should traders do?
We would suggest traders resist the temptation of shorting the U.S. dollar at this point. Whilst the index could drift a little bit lower, we wouldn't expect it to fall below $100, which simply doesn't provide traders with a sufficient risk/reward in our opinion. Especially as when Trump clarifies his fiscal plans there's every chance that the dollar will strengthen again and the index will retrace recent declines.
Going long with the U.S. dollar index is not something we would suggest traders do either right now. We think that recent weakness could drag the index down a touch more, so would suggest traders hold tight and wait for a better entry point in or around $100-$100.50 with a future target of $105. Whilst the big gains that were on offer in October have now gone, we still feel there is a reasonable 4.5 percent to 5 percent potential gain for traders over the next six months if the dollar weakens over the coming days or weeks.
In the meantime, a better option for traders might be to short the Australian dollar (NYSEARCA:FXA), which has rallied strongly against the U.S. dollar in the last week or two. We see the potential for it to fall by upwards of 13 percent in the next 12 months to 65 U.S. cents as rates rise in the United States and rates continue to fall in Australia.
Whatever you choose to do, we wish you the best of luck with your trades! We'll keep you updated with any changes to our views as and when they happen.
Disclosure: I am/we are long UUP.
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.
Additional disclosure: Short FXA