What’s next for the USD after setback at start of Trump’s second term?
The desk anticipates a bearish outlook for the USD following the Fed's policy update, which could catalyze further declines in the currency. Per the full note from MUFG EMEA, analysts Lee Hardman and James Roulston highlight that the market is bracing for a dovish shift from the Federal Reserve, potentially leading to a weaker dollar in the near term. This perspective is underscored by recent economic data indicating a slowdown in inflation, which may prompt the Fed to reconsider its tightening stance. With no high-impact events on the calendar in the next month, the focus will remain on the Fed's upcoming announcements and market reactions to them.
What the desk is arguing
MUFG emphasizes that the outlook for the USD is precarious as the financial markets respond to ongoing political and economic influences at the start of Trump's second term. The anticipated Fed policy update may catalyze another decline in the dollar's value, particularly if dovish signals are perceived in the announcement.
The USD’s recent softening may reflect broader anxieties around fiscal policy and its implications on economic growth. If the Fed hints at a slower pace of rate hikes or even considers adjustments in response to evolving economic conditions, it risks further loss of confidence in the dollar, driving it to lower levels against major currencies.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Fed policy changes could trigger additional weakness in the dollar.
- 02Political uncertainties surrounding Trump's second term are adding pressure to the USD.
- 03Traders should prepare for potential volatility driven by fiscal policy announcements.
Market implications
A lower USD could enhance competitiveness for U.S. exports, but could also lead to inflationary pressures as imported goods become more expensive. This dual impact necessitates close monitoring of economic indicators post-Fed announcement to gauge the full ramifications on the dollar's trajectory.
Risks to this view
The primary risks to this outlook stem from geopolitical tensions and unexpected shifts in domestic economic performance. Additionally, a stronger-than-expected Fed signal could reverse current USD softness, complicating short positions across FX markets.
Welcome to the MUFG Global Markets FX Week Ahead podcast with Leigh Hardman, Senior Currency Analyst at MUFG. It's Friday, the 24th of January, 2025. And joining me to pose some questions on the financial market themes for the week ahead is James Roustan, FX Institutional Sales.
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. Okay, great.
So thank you very much for joining me Leigh. We are here to do the podcast, the weekly podcast. There's a couple of big key topics that we want to cover off today.
If it's okay, we just jump straight back in. Yeah, sounds good to me. Fantastic.
Okay. So first up is the FX markets have been impacted by Trump's first week, obviously big week in the US, but how has it sort of played out in the FX space? Yeah, we have seen some big moves, like you say, in Trump's first week with the dollar selling off really across the board.
To us, that kind of mainly reflects some kind of initial disappointments amongst market participants that Trump didn't raise tariffs immediately at the start of his second term. If we look at how the dollar's performed since the US election, we've already seen the dollar obviously strengthened quite significantly. We look at positioning there and leveraged funds have built up very big, long dollar positions to the highest level since all the way back in September 2018.
So this was obviously a very crowded trade and that even that kind of initial disappointment that tariffs are coming in more slowly, that has triggered a correction lower for the dollar. Having said that, though, there's still enough there from Trump indicating that he does plan to go ahead with tariff hikes going forward. He's ordered reviews into the trade practices of US trade partners, including Canada, Mexico and China.
And he has set a deadline for the 1st of April to provide an update on those trade practices and to provide recommendations. So to us, this is likely to provide the justification then for Trump to go ahead and put higher tariffs in place and other trade restrictions. So this kind of more gradual, I guess, phase in of tariffs, while it may initially kind of weigh on the dollar, we still think ultimately these tariff hikes are coming and that when they're put in place, it's ultimately going to be supportive for the dollar.
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