Daily analysis 10.11.2016

, author:

Marcin Lipka

The dollar is becoming increasingly stronger. Significant changes in treasury bonds are suggesting that inflation may be higher. The USD/PLN is testing the level of 4.00.

Most important macro data (CET – Central European Time). Estimations of macro data are based on Bloomberg information, unless marked otherwise.

  • No macro data that could significantly impact the analyzed currency pairs.

Sudden change in market’s attitude

A strong wear-off of the dollar from yesterday has quickly turned into a clear increase in the USD. The dollar’s index only is 0.3% below its nine-month maximum. This is despite the fact that the dollar was testing its mid-term minimum on Tuesday night. What is the reason behind these changes? Is this situation only a result of the short-term sentiment changes or a beginning of fundamental changes?

The market expectations were only valid a few hours after Trump’s victory. Low quotations of the dollar against the euro, as well as against the yen, were a result of the assumption that Trump’s victory would cause a global increase in risk aversion. Moreover, it was expected to translate to lower consumer demand and delay the process of inflation reaching its target. All these factors would result in necessity of extending mild monetary policy and be negative for the dollar.

However, the fear among investors didn’t last for long. The stock markets begun to work-off their losses rapidly. This denied the theory of a weaker economic condition and lower inflation. This was shown perfectly by the moves of the ten-year treasury bonds. At approximately 6.00 AM on Tuesday, they were at the level of 1.71%. However, they were testing the 2.10% level at 7.00 PM, which is their highest level in ten months. Moreover, changes in two-year bonds were huge as well (from 0.70% to 0.91%). During one day, the market estimated that actions from Trump’s new administration will support prices growth, rather than limiting it.

Increase in expenses without revising trade agreements

The campaign announcements regarding an increase in infrastructural expenses, decrease in enterprise taxes and reduction of fiscal burdens for the wealthiest, should clearly stimulate consumption. Taking into consideration higher industrial metal prices, this basically has to cause inflation. It seems that the market is currently considering this scenario.

Therefore, it seems logical that the future interest rates should be higher than they would have been in the scenario of the lack of growth revival. However, there is at least one flaw in this view. The Congress is dominated by the Republicans, who are positive towards decreasing taxes, but they’re also skeptical towards increasing expenses. Therefore, changes that would clearly increase the budget deficit may be difficult. Especially taking into the consideration that economic development is near its potential.

Theoretically, higher inflation can be caused by more protectionist approach of the USA as well. A significant increase in customs duty combined with revision of trade agreements, may result in higher prices. However, the market participants shouldn’t consider this policy as positive. This reduces the American economic potential, as well as increases the slowdown risk for the other countries. As a result, this may cause a reduction of the global growth, instead of helping the USA. This would be a negative signal for the USD.

Therefore, within a few hours investors estimated that Trump will fulfill his promise regarding a decrease in taxes, the Congress will agree on an increase in expenses and the announcements of a more protectionist trade policy will not be fulfilled. We may also assume that the current market quotations are estimating a high likelihood of this scenario to be fulfilled.

In conclusion, the dollar should benefit from an optimistic approach towards Trump’s policy. Higher inflation will make the Federal Reserve’s actions regarding rate hikes easier. However, if it appears that there will be no fiscal stimulation, a more protectionist attitude would become dominating. This should fundamentally wear-off the dollar. It seems that the first mentioned scenario (stronger dollar) is more likely in the short-term. However, investors will listen to Trump’s statements very carefully. If they suggest that fiscal stimulation is uncertain and revision of trade agreements is becoming a priority, the dollar may become rapidly overvalued.

Weaker zloty

The zloty’s relatively positive condition shortly after Trump’s victory, was a result of the fact that Poland may suffer less from changes in the American trade policy than the other emerging markets. On the other hand, lower expectations towards the future interest rates in the USA were increasing chances for the local treasury bonds to attract foreign capital.

However, taking into consideration the market’s behavior which was described in the above paragraphs, the perspective of a stronger dollar, as well as of higher profitability of treasury bonds is currently negative for all of the emerging market currencies.

Therefore, perspectives for the zloty are mainly determined by the American assets. If the dollar, as well as the US treasury bonds continue their growths, the USD/PLN will grow as well, and the EUR/PLN will remain at a relatively high level. Taking the recent events into consideration, this is most likely becoming the base case scenario. This is at least until more unambiguous announcements from the new American administration.

This commentary is not a recommendation within the meaning of Regulation of the Minister of Finance of 19 October 2005. It has been prepared for information purposes only and should not serve as a basis for making any investment decisions. Neither the author nor the publisher can be held liable for investment decisions made on the basis of information contained in this commentary. Copying or duplicating this report without the written permission from Sp. z o.o is prohibited.

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