Aug 10, 2017

4 Reasons Why USD is Weakening and Possible Future Trends

Shortly after the US Presidential elections, the USD shot up and hitting a multi-year high, with investors expecting that a newly inaugurated President Trump will be able to revitalize the US economy through tax cut, infrastructure building and trade sanctions which all will assist in the strengthening of the USD. 8 months later, the USD has reached a 2 year low and has fallen rapidly by 6% against SGD within this short period of time.

There are 4 main reasons behind this sharp decline:

Reason 1: Chaos in Trump Administration

The rush of scandals that engulf the Trump administration and Trump's Apprentice style of rapidly hire and fire of key position holders in the Trump administration meant that the White House spent more time combating one crisis after another. Rather than putting priorities on policies that will boost the US economy directly, Trump focuses on enacting immigration policies and repealing Obamacare and wasted much of his political capital without getting much done. The failure of Trump and the Republican controlled government to repeal and replace Obamacare in July, created a big dent in the confidence of investors on whether this government can get anything done, despite having total control of the US government. The euphoria of an expectation of a massive fiscal stimulus is overcome by realism and the result is reflected in the falling US dollar.

Reason 2: Growth in the European Union

The EU region registered good growth figures after years of chaos of jumping from one crisis to another. With inflation starting to creep back into the EU region, investors expect the EU central bank to start dialing back on the quantitative easing policy that has been in place since the European financial crisis. This gave the Euro a strong shot into the arm leading to a strengthening of the Euro, which also put additional pressure on the USD.

Reason 3: Revival of China

In 2015, the weakening of the Chinese economy and the flood of Chinese money flowing out of China has seen both the crashing of the China stock market and a sharp depreciation of the China Yuan. The recovery of the Chinese economy along with a strong curb on an outflow of China Yuan  has lured investors back into the Asia-Pacific region resulting in a stellar performance in major Asia-Pacific stock markets.  The search of better investment returns in the Asian stock markets and the currency controls imposed on the Chinese Yuan have contributed to the outward flow of USD and thus more USD weakness.

Reason 4: No Inflation in Sight

The economic model Philips Curve predicts that there is a direct relationship between unemployment and inflation. Whenever unemployment is low, inflation tends to rise. However, the US economy is currently experiencing low unemployment and yet inflation remains low and nobody has a good explanation why the current environment is going against conventional economic wisdom. The US Federal Reserves sets their interest rate direction with the Philips Curve as one of their key indicators. With unemployment hitting record low in US, the Fed is basing their decision to raise interest rate on only one factor of the Philips Curve in place and having faith that this short term distortion will eventually give way to the economic model which predicts a rise in inflation. This also prevents the Fed from increasing interest rate too aggressively as it might accidentally trigger off a slow-down in the economy.

A Rebound in USD in Sight?

With most of the analysts generally pessimistic in the trend of the USD, it is no surprise that age old advice of "Buy when people are fearful" becomes valid again. The trigger point for the rebound is the fiery exchange between North Korea and President Trump threatening to nuke each other into stone age. With no idea what President Trump or President Kim Jong Un will do, the world decides to purchase some insurance by moving some funds back into safe haven USD. The strong US job reports and relatively high value of European and Asian Equities have prompted investors to take some profits off the table with many expecting the traditional 3rd quarter market correction given that the market has performed so well this year. 

So if you are looking to a vacation in US in the near future, picking up some USD now might be a good idea!


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