Team Trump has shaken up foreign leaders and currencies market (again), but analysts are struggling to figure out whether to take the weak (or is that strong?) dollar policy seriously, literally, neither or both. Welcome to 2017.
To recap: Yesterday, the FT reported that Peter Navarro, the president’s chief trade negotiator, considered the euro to be “grossly undervalued”, sending the European currency jumping. His comments were later bolstered by the president himself, who noted that “you look at what China’s doing, you look at what Japan has done over the years, they played the money market, they played the devaluation market and we sit there like a bunch of dummies.”
This has not gone down terribly well in Tokyo, and it also forms a confusing picture, after the president’s new administration has swung between seemingly favouring a weaker dollar, and then not, on a rapid cycle of late, not to mention the tricky task of matching up a preference for bringing jobs back home to the US with a weaker currency.
Difficulties around figuring out the official line notwithstanding, economists and analysts are heroically trying to figure out what this all means. Here’s a taste:
Kit Juckes at Société Générale takes a look at the metrics used here, with interesting results:
Peter Navarro cited the Peterson Institute of International Economics when saying that the implied fair value for the German mark was EUR/USD 1.18 and indeed, that is the Fundamental Equilibrium Exchange Rate-consistent rate in PIIE’s November 2016 update of FEERs. The focus on the PIIE work suits the Trump administration because it concludes the dollar is significantly overvalued (by 7% relative to a FEER measure), and that equilibrium FX rates against the dollar would only see the Argentine peso need to appreciate. Mind you, the Euro is not, on the PIIE calculation, undervalued overall (nor, indeed, is the Yuan). It’s the US dollar that’s out of line in those relationships.
But since a FEER is an FX level that would stabilize balance of payments imbalances over time, what this really amounts to is that the Trump administration is criticising all the major current account surplus economies. Germany, Japan and China are the big ones by size, but they’re not the big ones in terms of surpluses. Norway, Switzerland, Sweden, Singapore, Malaysian, South Korea and Taiwan could all easily catch the eye of the new team at the White House. Of all of these, the one which appears most undervalued to me is the Swedish krona.
Morgan Stanley’s Hans Redeker and team think it’s too confusing to act on all this yet:
Economies running high trade surpluses with the US and having over invested in globalisation seem most vulnerable to the US trying to move supply chains back into the US. The same Peter Navarro who intervened yesterday said a couple of weeks ago that ‘it does the American economy no long-term good to only keep the big box factories where we are now assembling ‘American’ products that are composed primarily of foreign components,’ adding ‘we need to manufacture those components in a robust domestic supply chain that will spur job and wage growth.’
A weak dollar policy seems to be consistent with this approach, but it does not answer the question of how the US will impose a weaker dollar when similarly requiring more capital to relocate its supply chains back home. Higher capital needs suggests higher domestic savings inspired by higher yield or a higher dollar driven by capital imports. The US administration’s communication lacks clarity on this conundrum and hence its market impact will be limited to position squaring.
German bank Commerzbank considers Mr Navarro’s comment to fit into a pattern of “alternative facts”, with analyst Ulrich Leuchtmann advising clients to “buckle up for a currency war that might become nasty”:
It shouldn’t surprise that Navarro has a different view. He is known for his notorious eccentric stance on many economic issues, and he is known to be one of the most explicit China critics. But expressing his views as a faculty member of UC Irvine is one thing; expressing the official stance of the US government is another.
With his statement he has in fact fired the next salvo in the currency war the US administration is currently conducting against the rest of the world.
Inconsistencies could result in ineffectiveness of large parts of this policy mix. Something to keep in mind. Currently I am bothered by another fear: Other governments and central banks might at some point not tolerate these deliberate provocations by the US government and might fire back. If the London Accord of the G7 governments and central banks breaks up, we will be in a fully-fledged currency war, which would cause heavy collateral damage in terms of world GDP growth, international trade and financial stability. So far all other G7 governments and central banks keep their weapons tight. This implies further room for USD weakness, as the US administration might feel assured in their new locker room talk about exchange rates.
Citi notes that Mr Navarro’s comments sit in an interesting context, given Mr Trump’s lack of warmth towards the EU more broadly:
Navarro’s comments echo previous statements from President Trump, calling the EU a “vehicle for Germany” and complaining about imbalances in car exports. Germany is on the US Treasury’s ‘watch list’ because of its trade surplus with the US and its current account surplus (but not as a currency manipulator). We are not sure whether Navarro means that the euro is undervalued, as Merkel’s riposte seems to suggest, or whether he only means that the “implicit Deutsche Mark” is undervalued. The latter could only be resolved via real exchange rate adjustment through higher inflation in Germany or euro break-up.
More generally, Navarro’s comments add to Trump’s calling NATO “obsolete” and the EU “bureaucratic”, attacking at least two other cornerstones of German foreign policy. So far, the German government’s response has been to insist on US commitments to international rules and to accept that TTIP is unlikely to move forward. As in the case of Brexit, the German government is striving to maintain EU unity. We see no indication yet of how the German government would respond to potential US measures such as BTA, but highlight that Berlin has in the past resisted calls to take policy steps to reduce its trade and current account surplus.