Roger J Kerr says current financial market sentiment, positioning and commentary would not suggest that the US dollar is about to do an “about turn” and fall away over coming months

Summary of key points: -

• Financial markets hold their “Rinse and Repeat” conviction on Trump policies
• Aussies now price for a February interest rate cut

Financial markets hold their “Rinse and Repeat” conviction on Trump policies

The appreciation of the US dollar on global foreign exchange markets since October last year on the back of Trump’s tariff intentions, perceived higher future inflation and the Fed winding back on their interest rate reductions this year, is proving to be an exact mirror of the initial USD appreciation when Donald Trump was first elected President in November 2016 (refer chart below). The Trump 2.0 “rinse and repeat” displayed by the FX markets is a remarkable action replay of the previous Trump 1.0 FX price action. According to the 2016/2017 script, the US dollar should now start to run out of steam, despite climbing to 109.50 on the Dixy Index following a stronger than expected Non-Farm Payrolls jobs result for December last Friday. We have not yet seen any catalyst in the form of weaker than expected US economic data to cause unwinding of the profitable Trump Trades (long USD, short-sold US 10-year Treasury Bonds). The US dollar has continued to appreciate, and the bonds sold off again to nine months highs of 4.76% on the employment news.

Back in January 2017, the US dollar did not appreciate any further once President Trump was sworn in. The currency markets progressively unwound all the previous USD gains, sending the USD Dixy Index down 8 points from 101.00 in January 2017 to below 93.00 by July 2017.

Are we once again on track for an eight point drop in the USD Index over the next six months as history eerily repeats?

Current financial market sentiment, positioning and commentary would not suggest that the US dollar is about to do an “about turn” and fall away over coming months. The markets are expecting (and have priced for) a “big bang” tariff announcement from Trump once he is elected, which is contrary to the more “layered” approach to tariff protection favoured by his Treasury Secretary, Scott Bessent. Donald Trump is often quoted as wanting lower US interest rates and a lower US dollar value to help US manufacturing exporters. Off course, his stated policy intention with tariffs causes the opposite impact. He will not be happy with the current trends of higher long-term interest rates in the US and the stronger US dollar currency value. Expect come social media ranting on this subject. Like all matters with Donald Trump, nothing adds up or is coherent. The “America First” protectionist and isolationist economic policies are polar opposite to his “Putin-like” imperialist expansion plans with Greenland and Panama. However, there is always more to Trump’s statements, it is likely that he is repaying his mining industry mates for financial support to his election campaign with the Greenland annexation intentions.

The financial markets and the Federal Reserve are both expecting US inflation to increase over 2024 due to tariffs and a robust economy.

However, two key upcoming pieces of economic data have the potential to upset the applecart in respect to the current market conviction.

Core PCE Annual Inflation Rate to January 2025 (due for release 28 February 2025)

The FX market’s expectation that inflation will increase this year may be in for a nasty surprise when the extraordinarily high 0.70% increase in the core PCE measure in January 2024 rolls out of the annual rate calculation. Large increase last year in housing (rents) and health costs are not going to be repeated this year. The annual core inflation rate is likely to decrease from the current 2.80% level to 2.40%, or lower – which is the opposite to what the markets are currently anticipating.

More largescale historical revisions to the Non-Farm Payrolls (due for release 7 February 2025)

When the January employment data is released on 7 February, the US Bureau of Labour Statistics are expected to release significant downward revisions to the previously announced 2023 and 2024 monthly Non-Farm Payrolls numbers. The notoriously inaccurate monthly figures are surprisingly still the key focus for the financial markets in terms of being an accurate indicator of the strength of the economy and inflationary impacts from the labour market supply and demand (through wages trends). Back in August last year the Bureau of Labour Statistics revised down the job increases to March 2024 by 818,000. A second major revision is now due as part of their “annual benchmark revisions”

The markets also appear to have conveniently forgotten that Trump’s DOGE (“Department of Government Efficiency”) taskforce headed by Elon Musk and Vivek Ramaswamy is going to slash and burn costs (i.e. jobs) in US Federal Government agencies, institutions and departments in an attempt to secure US$1 trillion to US$2 trillion in spending reductions to reel in the budget deficit. As most of the increases in Non-Farm Payrolls jobs over the last two years have been in the Government sector (under Bidonomics policies), it is not rocket science to come to a conclusion that employment data will trend to the softer side this year (with or without the historical revisions!).

Should the two economic data releases discussed above evolve as expected (i.e. softer), the Federal Reserve members may be forced to once again to change their stance back to three of four 0.25% interest rate cuts this year, rather than the two cuts signalled from the 18 December Fed meeting. The US dollar would give up its recent gains under this scenario.

Aussies now price for a February interest rate cut

The Australian dollar remains under constant downwards pressure from the stronger USD and weaker Chinese Yuan exchange rates. The AUD/USD exchange rate has depreciated 11% since the 0.6900 level on 30 September 2024 to 0.6145 today. The weaker AUD has been the major factor behind the NZ dollar’s similar 12% depreciation form 0.6340 to the current 0.5560 rate over the same three- and half-month period. There continues to be no separate or independent investor or trader interest in the Kiwi dollar as our interest rates remain below those of the US. We simply follow the Aussie dollar movements in day-to-day FX market trading. Therefore, any assessment of future NZD/USD shifts from the current cyclically low levels has to be based on future developments with the Australian dollar.

Following last Wednesday’s Australian monthly CPI indicator outcome for the month of November, a number of Australian bank economists have once again adjusted their predictions to that the Reserve Bank of Australia (“RBA”) will now cut their OCR interest rate at their 18 February meeting.

Previously, the majority of forecasters were picking a May rate cut. The interest rate change was a little surprising as the annual inflation indicator increased from 2.10% in October to 2.30% in November. There will be a much more accurate gauge of Australian inflation trends when the official CPI figures are released for the December quarter on Wednesday 29 January. A 0.50% increase is expected for the quarter, lowering the annual rate of inflation from 2.80% to 2.20%. However, it should be remembered that Government subsidies on electricity prices are artificially reducing the annual inflation rate by 0.40%. The RBA exclude the electricity price subsidies in their deliberations, and they also focus on the “trimmed-mean” CPI number, which is still running at 3.50% per annum.

Should the December quarter’s inflation result be above RBA and market consensus forecasts and the December employment data on 16 January again be another strong increase (as was the trend all through 2024), then the February rate cut predictions may be forced to change once again. The Australian dollar might finally find some support with the potential above forecast inflation and jobs outcomes.

Whilst the domestic economic data may have a minor impact on the Aussie dollar, the dominating influence is still all things related to China. Recent Chinese economic data has printed on the softer side and long-term bond yields in China are tumbling (down from 2.60% to 1.60% over the last 12 months) as the economy enters a deflationary cycle similar to what Japan previously experienced. Negative economic news out of China is always bad news for the Aussie dollar as it is traded as a proxy for the Chinese economy. There is always speculation that the Chinese authorities will step in to assist the economy with large monetary and fiscal stimulus packages. The stimulus measures enacted through 2024 do not seem to have prompted Chinese households to spend more and save less so far. Households are still worried about falling property values.

It does seem that the Chinese Government has come to the point that they will need much larger fiscal policy injections into their economy. Watch this space over coming weeks on this front.

The Chinese central bank, the People’s Bank of China (“PBoC”) has been actively defending the Yuan from depreciating further and moving above the 7.3500 level against the USD. The Chinese Yuan has recovered from the 7.3500 level on three previous occasions since October 2022 (refer to the chart below), however the overall USD strength since October 2024 has it forced back to that level again. Upcoming Chinese economic data to look out for includes retail sales, industrial production and GDP growth numbers on Friday 17 January. The Aussie dollar remains closely correlated to the Yuan movements.

The timing of interest rate reductions in Australia could play a crucial role in their upcoming general election, which must be held before May 2025. The Albanese Labour Government is under pressure for causing a good part of their inflation problem (therefore elevated mortgage interest rates) through excessive State and Federal fiscal spending. Yet another change of Government in Australia back to the right of centre, Liberal/National Coalition would follow similar trends all around the world we are observing at this time. The US, Canada, New Zealand, France, Italy, Finland, Greece and several others have all moved to the right following voter dissatisfaction with the cost of living increases from the left of centre regimes in power through the Covid pandemic years. Federal elections in Germany are to be hold on 23 February (originally scheduled for September 2025) after the collapse of Chancellor Olaf Scholz’s three-party coalition government.

A change in political power in Australia back to the Liberals would be viewed as positive for the Australian dollar, however the dominance of the USD and Yuan movements over the AUD’s fortunes will still prevail.  

*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981.