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Fundamental Forecast for US Dollar: Bearish

Talking Points:

  • Trade wars carry a global risk, but the blowback to the Dollar is too often under appreciated
  • Talk of corporate buybacks is starting to lose its speculative momentum but Q2 earnings is to start
  • Monetary policy is another consideration for USD trading with the Fed’s report to Congress and CPI

The Dollar’s Standings in Trade Wars

There has been a lot of reference to trade wars ‘finally’ starting this past week when the United States’ $34 billion tariff on a list of Chinese goods – and China’s concurrent retaliations – went into effect. However, this economic scourge has been underway for weeks. The metals tariffs with which the US initially kicked off the growth-at-others’-expense approach has been in place for some victims for a while. In the end, the mere threat of large scale import taxes is enough to draw attention to the fact that the markets have run well beyond the bounds of reasonable value – and are in no way close to a meaningful discount. Yet, for the Dollar’s part, the risk in the retaliation to the United States’ policy. China has directly met the US tit-for-tat and intends to do the same in approximately two weeks when another $16 billion duty goes into effect. Where the real risk lies is in the application of pressure on developed world counterparts – like the European Union, Canada and Mexico. Few countries will be interesting in siding with China given its history of flouting open trade rules, but other major economies would be more than willing to band together in order to protect their own economic interests from the US and find alternative routes for their goods and services. Keep an eye on that open-ended auto tariff President Trump threatened – and the EU’s $300 billion response threat.

The Safe Haven Aspect is…Complicated

Interestingly enough, after the US-China tariffs went into effect at 00:01 Washington time, where there was an ominous feeling across global capital markets; US assets followed Friday with a bullish close. The benchmark equity indices (Dow, S&P 500, Nasdaq) all advanced through the session; but the enthusiasm would even carry over into other risk assets that trade during New York hours – such as the emerging market derivatives, high yield fixed income, and Yen crosses. Is trade wars no longer a concern? Perhaps it is fully priced in? Maybe it is seen as only a problem for those in the sightlines of US policy? It is certain in my view that the pressure on trade will sink sentiment. At such remarkable levels of exposure, investors already concerned are just looking for a reason; and this is a very good one. So what happens should we see sentiment fall apart over the coming week or further into the month? Will the Dollar revert to its traditional haven status or will distortions make it a risk currency? In the event of a full-tilt financial crisis, the Greenback may draw foreign capital for the absolute liquidity of its Treasuries and money markets. However, a descent that doesn’t tip fully into panic will afford the market with room to question the US currency’s fitness and will likely see it retreat. Beware this aspect. A true turn in sentiment may be closer than you many appreciate.

Does the Fed Still Matter for the Greenback or is it Just a Bearish Factor?

With concerns starting to fix more heavily on general sentiment in the financial system, it easy to be swept up in the all-consumer influence this theme can carry when activated. Yet, the clouds threatening an implosion in speculative markets have been on the horizon for a very long time, and we have yet to see the true flashes of lightening from the storm. In the meantime, it is important to keep tabs on all other effective fundamental themes that will drive the Dollar to wax and wane in the interim. Monetary policy is still an important aspect of the currency’s general standing in the FX market. It is also unmatched among the majors for both current rate and forecasted change – though you wouldn’t necessarily derive that advantage from price action alone. When evaluating the complicated nature of how influential rate advantages are or are not, look no further than EURUSD. The Fed and ECB were on extreme divergent courses last year and are not materially closer to even truly course correcting to actually narrowing the disparity today. And yet, the Euro has held its own against the Dollar. We can’t exactly lift the Fed rate forecast more dramatically or it would risk toppling speculative markets – which would in turn bring rate hikes to a hard stop. That said, if the Fed is forced to downgrade its efforts, the Greenback could definitively feel the pain of lost – if unused – premium. With the June consumer inflation (CPI) figure and the Fed’s monetary policy report to Congress due this week, expect this theme to weigh in.

It’s Earnings Season, Will Investors Notice?

One more factor that will be big for headlines but questionable for its influence on the US currency and capital markets is the start of 2Q corporate earnings season. This is the lifeblood of returns that are expected in the financial system and lead market participants to evaluate their risk-reward, yet earnings have played little more role than just padding headlines with impressive statistics while markets extended their already impressive course. Yet, we may no longer have that default setting where good news is leveraged and bad ignored. These past few weeks, the conversation has focused on the scale of corporate buy backs hitting records and keeping the markets buoyant – though clearly not further advance. If earnings start to come back down to earth, these large infusions back into the market will be expected to deflate. And if the large corporations, central banks and foreign investors are all turning away; what is left to keep this bull trend rising? Keep an eye on the JPMorgan, Citi and Wells Fargo earnings updates due on Friday.