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The dollar began Monday on a weak note after significant losses last week due to a potentially weakening U.S. labor market, while concerns over a global trade war led investors to safe havens, lifting the yen and the Swiss franc.
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The Wall Street conventional wisdom in November was that President-elect Donald Trump's tariff plans would boost the U.S. dollar. Instead, with the tariffs in place, worries about an impending recession have overwhelmed any positive benefit for the greenback.
The ICE U.S. Dollar Index traded as high as 104.31 on Wednesday, before Trump's tariffs were unveiled. It fell following the announcement and hit a low of 101.27 on Thursday, a 3% swing in roughly 24 hours. Even with a modest rebound on Friday, the index finished down for the week and the dollar is now weaker than it was before the presidential election in November.
"The blowback from Trump's tariffs are already kind of hitting the U.S. economy, and that's not what investors were expecting," said Chris Turner, global head of markets at ING. "Investors were expecting that tariffs would be bullish for the dollar and bad for the rest of the world. But I think the U.S. economy wasn't in a strong enough position to take these maximum tariffs right now."
The ICE US Dollar Index fell sharply on Thursday, the day after the U.S. tariff announcement.
While Trump has at different times spoken favorably of both a strong and a weak dollar, traders clearly took his election as a boost to the greenback. The dollar index rallied sharply following Trump's win on Nov. 5 and then continued to climb over the next two months, briefly trading above 110 in mid-January.
Since then, the index has been retreating amid growing signs of economic weakness in the U.S. and as Trump's trade policies proved more aggressive than Wall Street bargained for.
Kathy Kriskey, head of alternatives ETF strategy at Invesco, is still hopeful for a "short-term pain, long-term gain" outcome from the Trump administration's economic plan, but says market confidence is shaken.
"The currency reflects the health of the economy, and so I think that right now we are very concerned. We sort of believe Trump has a plan but we don't know, definitively, what that plan is," Kriskey said.
Flight to safety
To be sure, foreign currencies have not moved uniformly against the dollar lately.
Traditional safe-haven currencies like the Japanese yen and Swiss franc have seen some of the biggest gains. But more economically sensitive currencies like the Australian dollar that are more closely tied to commodities have lost ground against the dollar, especially on Friday, which looked like a "more traditional risk-off day," Turner said.
The flight to safety in other asset classes is also having a mechanical impact on the currency market. For example, the drop in U.S. Treasury yields makes it less attractive for foreign investors to hold dollars or U.S. bonds and collect interest, while dumping of U.S. equities likely includes foreign investors who are shifting that allocation to domestic stocks, selling the greenback along the way.
The euro has proven one exception to the risk-off trade, rising against the greenback this past week even though it's typically viewed as less of a safety play than the dollar. Kriskey said growing optimism around a potential peace deal in Ukraine and promises of more government spending from countries like Germany is helping to bolster the euro.
"It's been bizarre that this new [Trump] administration is actually helping Europe to get their house in order and for those currencies to look more attractive," Kriskey said. Betting on the euro to rise is one of the strategies used in the Invesco DB US Dollar Index Bearish Fund (UDN).
What's next
The good news for investors is that the sharp move in currency markets this week doesn't appear to pose an immediate threat to the economy or financial system. Amol Dhargalkar, managing partner at Chatham Financial, said companies may look to be more aggressive in hedging their currency risk in the months ahead but that corporates typically do so in a conservative way, meaning there should be no major trading losses from this week's moves.
"Their main objective is not to take a view, for the most part, on the currency. The main objective is really to mitigate the risk," Dhargalkar said.
While there may be hedge funds who were on the wrong side of the dollar move, the foreign exchange market is also enormously liquid, deep and actively traded around the world, meaning it should be able to withstand 3% moves in the dollar without too much issue.
"This is well within the range that the market can digest," said Ken Miller, portfolio manager of the Simplify Currency Strategy ETF (FOXY) and the firm's head of trading. He compared this past week favorably to the situation the currency markets faced in the 2008 financial crisis. "That was a completely different animal in that banks were at risk and counterparties were at risk. I don't sense that here."
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