US Dollar Projections Post-FOMC: Discussions on Trump Policies, BoJ and the outlook for the Yen

Welcome to the MUFG Global Markets FX Week Ahead podcast with Derek Halpenny, Head of Research, Global Markets EMEA and International Securities. It's Friday the 20th December 2024 and joining Derek to pose some questions for financial market themes for the week ahead is Jack Greenslade from the Global Customer Marketing Group. The following podcast is intended for professional investors and eligible counterparties only and not for retail clients.

Any content should not be regarded as an offer to conduct investment business or an investment recommendation but for information purposes only. Hi Derek, how are you? Good Jack, yes and you?

I'm very well thank you. Last podcast of the year. Indeed, indeed.

Looking forward to Christmas now, looking forward to a bit of a break. Yeah, absolutely. Me too.

Yeah, me too. It's been a busy, busy last few weeks actually, hasn't it? I guess firstly, let's talk about the December FOMC meeting.

So the decision last night, I guess, did you think the cutting rates was justified, especially given the recent US dates we've seen? The short answer would be no. I don't think it was justified.

To explain that a little bit, like clearly the political aspects around this meeting I think made it quite difficult for Powell and the FOMC to have reined back what was long expected, i.e. a cut, would have been construed as a signal from the Fed in terms of Trump's policies being inflationary next year and they just didn't really want to do that, obviously. But when you look at the data, the inflation data, the core CPI of 0.3%, that's the fourth consecutive month of a 0.3 core print, then the retail sales was pretty decent. And generally, you know, the economy has been resilient.

And of course, the FOMC, in the summary of economic projections, revised up the GDP estimate for this year. So all in, there really wasn't the obvious justification for cutting. And in reality, they shouldn't have cut.

And hence this, I guess, offset in terms of the communications. Yeah, really. And of course, you know, we saw that big surge in the dollar as well to, you know, two year highs.

At what point would you say that the dollar strength becomes a bit unpalatable for the Fed and the US government? Yeah, I don't, I don't think we're at those kind of levels. Certainly, let's say from an economics perspective.

So let's talk about just the Fed's perceptions of dollar strength. Obviously given what the Fed is concerned about, and why they were hawkish in the communication last night is, you know, their concerns about inflation have, I think, risen a bit, and probably so given the inflation data that I mentioned. So in that context, dollar strength is good, given the primary focus of the Fed.

Also, we have to remember that just the construct of the US economy, you know, we're talking about exports that total a bit over 2 trillion, 2.2. That kind of level of total exports makes up about seven, seven and a half percent of GDP. Yeah.

So that is a pretty small total. So you know, the US economy is classed as a large closed economy. So from a macro perspective, in that sense, it doesn't have a huge overall GDP impact.

Of course, the S&P 500 in terms of revenues made abroad, a bigger impact, 30% of revenues are from abroad. So there could be a point when the S&P starts to fret about dollar strength. But clearly, given the performance of the S&P 500 this year, we're certainly not in that territory just yet.

I think from Trump, a far more complicated answer, really, who knows? You know, one day, I think he seems quite proud of the idea of the dollar, you know, being strong under his presidency. And he made references to that in relation to the performance of the dollar in 2018, 2019.

But then he's also complained about it. And certainly in terms of countries trying to offset tariffs by weakening their currencies, he couldn't moan about that. But there's not a whole lot he can do.

Like we do have the Stabilisation Fund. But you know, there are controls to a degree in terms of the financing of that, that wouldn't leave it completely in the hands of Trump in terms of how he could finance aggressive, sustained intervention. So I think that kind of strategy is not really credible.

An accord like, you know, a Mar-a-Lago accord, which has been spoken about, of course, you know, he's a negotiator getting a bunch of the key countries together to try and iron out some deal on FX. You know, with Trump, absolutely, it's feasible, he could try that. But I think, would he get buy-in?

And in particular, would he get buy-in from China? Because if you look back at the Plaza Accord, and what happened to dollar-yen in the aftermath of the Plaza Accord, most economists, and I would certainly say this as well, that definitely was one element of pushing the Japanese economy into the period of deflation that we had for a number of years. So in that sense, it's something China, I think, would be very wary of repeating, given they do not want to happen to them, what basically happened to Japan in the 1990s.

So I think buy-in would be difficult. Yeah, it's interesting you mentioned China, because obviously, you know, the authorities there recently suggested they could let the renminbi weaken to effectively dampen down the US trade tariffs. Is this something you think is realistic or would be effective?

Well, for sure, you know, dollar appreciation is one way to, sorry, yeah, dollar appreciation versus CNY is one way to offset the impact of tariffs in terms of demand for Chinese goods in the United States. So I think there is an element of that for sure. Up until now, I think it's been quite contained.

Like if you look at G10 FX versus the dollar, you know, the dollar is up about, depending on your currency pair, about, you know, 8%, 9%, a little bit less against the euro. But you know, in that sense, there's more scope for CNY weakness, given the fact that dollar CNY is only up about 4% since the end of September when the Trump trade came back into play. So I think maybe there's a greater control by the PBOC, the fixings certainly indicate that, to limit the upside.

But then in circumstances if the, or when the tariffs come, and if they're certainly aggressive, 20% or more on everything, then I think, you know, we could get another bout of dollar CNY weakness. So we have it up at 747.50, clearly not on 60% tariff, something much smaller than that in a step, 20% perhaps. And then also incorporated into that is the assumption that there will be some more aggressive fiscal stimulus to boost domestic demand in China, to offset the weakness, the potential weakness in external demand because of the tariff.

So there's an assumption in there in terms of the overall strategy of China in countering the tariffs that are coming. Everybody talks about Trump being much more prepared because he expected to win this time, whereas he didn't expect to win in 2016. But we can say the same about the rest of the world as well.

China and the other countries are also going to be a lot more prepared for what's coming in terms of tariffs. So we should remember that as well. For sure.

I guess, you know, it'd be remiss of me if I didn't also mention the Bank of Japan. We're a Japanese bank. What are your expectations for the yen in the near term?

You know, could we see a retest of the annual highs we saw just a couple of months ago, given how dovish the Bank of Japan was in their meeting this month? Yeah, the communications this morning from Governor Ueda certainly were not consistent with our view that they'll hike in January. Indeed, up until last week, we thought they could have hiked today, but then the signals via the media was that they wouldn't go today.

So we pushed it to January. But if you consider what he was focusing on, wages and wanting more information on wages, he acknowledged there will be some more information by January, but that the big picture, broader information wouldn't be available until March or April. So you'd question how much more information they'll have in January, the 24th of January, compared to today.

Secondly, US economic policy was a big uncertainty. And Ueda said he wanted time to assess the potential economic impacts from policy announcements. If we get day one tariffs, that means the BOJ has four days until the policy meeting to make its assessment.

Yeah, you know, feasibly, you could argue they could they could make a quick assessment and do a call. But again, the window's pretty narrow. So, you know, I think dollar yen is up considerably, in part on less doubts about January, and then have been pushed further into the into the future.

So I'm a bit surprised because, you know, everything is unfolding as it should be. I do think there's political influence here to a degree. And we have the budget that's the supplementary budget that's going through the diet.

And perhaps, you know, there was government pressure to not hike and to be dovish in order for that to go through smoothly, given the LGPs and minority at the moment in the diet. So there's that political influence, perhaps as well. So I wouldn't rule out January, but certainly today, a lot less conviction.

So probably the big variable that could change and bring January back into being more credible is, of course, FX. So you mentioned going back up towards the 160 level, back into intervention territory. Yeah, I think they would intervene if we got up to those levels.

And certainly there would be pressure at that point to become more hawkish and maybe to hike. So I think dollar yen is probably the one to watch in terms of whether they move in January or not. I guess as it's our last podcast of the year as well, if you had to choose one thing for next year, what would it be and why?

Well, you know, we've got our publication in January, we'll have the five themes of the year. They're all either directly or indirectly Trump related. So I think definitely from an FX perspective, tariffs is really massively important.

And trying to look at something else that maybe is a little bit less obvious is, you know, we've had this constant period of US exceptionalism being the driving force of dollar performance, which I don't disagree with necessarily. But I do think that kind of theme is maybe starting to become overpriced in the markets. And what does worry me about Trump in 2025 and beyond is inflation, which we could have maybe got a sense of from the Fed and Powell last night.

And the big question for me is Trump's ability to fuel strong, non-inflationary growth going forward. He was able to do that in his first term in office, because inflation was so low, the economy was at the bottom of its cycle, the Fed were beginning to tighten policy, we're at the opposite ends this time. And, you know, his fiscal, his tax cuts and his kind of plans on that front, along with the tariffs, inflation is a much higher risk.

And therefore, this side of a global inflation shock, inflation expectations are a lot less anchored. And therefore, nominal yields moving higher could well be with breakevens moving higher as well. And therefore, real yields aren't moving higher.

And that becomes a potential negative for the US dollar. If there's a supply concern about US debt, which is another plausible risk, that also would be negative in terms of if that's what is lifting longer term yields. So, you know, I still think later next year, the dollar strength will start to reverse on some of these problematic issues that Trump will face.

Great. Okay, well, thank you so much for speaking to me. And I'd like to wish you and those listening a wonderful festive period and Happy New Year.

Good luck for 2025. Indeed, thanks. And the same to you, Jack, and to of course, all our listeners as well.

Thank you. Thank you for listening to this MUFG Global Markets podcast. Rate, review and subscribe and contact your MUFG sales rep for more information.

Come back in 2025 for more insights from the global markets research team.