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March FX Outlook – Trump, the Fed and European politics

The FX market continues to wait for more detail on Trump’s economic proposals, which may well be outlined more clearly by the end of the month.  There was no significant new detail supplied in his February 28th speech to Congress. Regardless of the timing of the Trump proposals, March will have an important Fed meeting and potentially impactful European political developments, discussed in more detail below.
The USD was little changed in February as the market awaited news from Trump, but the EUR suffered somewhat from concerns surrounding the French elections. However, recent comments from the Fed have increased the chances of a March rate hike suggesting the USD bias is still higher in the absence of concrete evidence that the economy will suffer from Trump’s agenda.
Three-month US Dollar Index movement:
USD Index
Outlook for March

1) The Trump and Republican agenda
Trump’s speech to Congress didn’t really add any meat to the bones of his proposals, and the market still awaits details of his infrastructure spending and tax reform proposals. We continue to see these as likely to be supportive for the USD when they come. While the infrastructure spending plan may be less stimulative than some hope, the Fed isn’t really assuming much about it at this stage so any extra stimulus would be USD positive via the implications for tighter Fed policy. The tax reform proposals are also likely to be USD positive, even though the tax reform itself will not come into effect until 2018 at the earliest. Despite this, the House Republican plan looks potentially positive for the USD from several angles. It is likely to be modestly stimulative, but more directly could help the USD via the implications of a border adjustment tax. While there is some disagreement among economists about the potential size (and even direction) of the USD implications of such a tax, we would expect it to be supportive for the USD in the short to medium term, especially against the largest trading partners. However, some more detail and a concrete proposal from Trump’s or the House Republicans is necessary if fiscal plans are to have an impact on the USD in March.

2) FOMC – a March rate hike is now in play. Key date: FOMC meeting March 15
Comments from several Fed officials in the last week, including influential NY Fed president Dudley who is very close to Yellen and has typically been a dove, suggest that the Fed could raise rates again at the March 15 FOMC meeting. Dudley said the case for a hike has become “a lot more compelling” since the election and this has led the futures markets to price a March hike as a 88% chance from just 33% on February 27. The USD has risen in response, but at this stage continues to lag well behind its normal relationship with yield spreads. On the basis of the yield spread correlations seen in recent years, the USD should already be a lot higher. Market participants tend to put this down in large part to political uncertainty related to the Trump administration, and some have suggested this has influenced the willingness of sovereign wealth funds and central bank reserve managers to hold the USD. Nevertheless, higher US yields are still likely to provide USD support from current levels, but with a Fed tightening now seen as more likely than not, there are significant USD downside risks if the Fed doesn’t move.

3) European elections. Key date: Dutch election March 15
March 15 sees the Dutch go to the polls and all the press coverage is about whether Geert Wilders’ right wing “populist” Freedom Party will get the most seats. Recent polls have actually seen them dropping back and they are now broadly neck and neck with Rutte’s current governing Liberal Party, but in reality even if the Freedom Party do get the most seats, there is still effectively no chance of them forming a government, as none of the other parties are prepared to join a coalition with them. With 150 seats in the parliament, and 76 seats needed to form a majority, even on their best opinion poll showing the Freedom Party will only get around half the seats it needs.
There is also continued interest in the French presidential election, with the markets still concerned about the possibility of a victory for the FN’s Marine Le Pen. However, while opinion polls generally project that she will narrowly win the first round of voting, polls suggest she is expected to lose the second round by a wide margin as second preference votes will not tend to support her given her extremist policies. The market nevertheless remains concerned, but is probably pricing the risks of a Le Pen victory too highly because of the unexpected wins for Trump and Brexit last year, though these were always much closer races in the polls.

4) UK likely to trigger Article 50 to start the process of leaving the EU
This is to some extent a formality, as the House of Commons has already passed the necessary legislation, but it is currently going through the House of Lords. The Lords may attach an amendment or two which the government will probably reject, and this process could eat up some time, but the decision is still likely to be formally made by the end of March as Prime Minister May has promised.

Currency Outlooks

EUR/USD fell modestly thorough February despite breaking briefly above January’s high at the beginning of the month. Political uncertainty weighed on the EUR, mainly based on improving French poll readings for Le Pen although concerns about Greece continue to bubble beneath the surface. The downside continues to be slightly favored against the USD as long as the Fed deliver a rate hike in March, though it will be difficult to break below the lows of the year at 1.0340 without some more clarity on US fiscal plans. If a Fed hike is not forthcoming, and the markets start to overcome their fear of a Le Pen victory in France (which in reality remains unlikely) the EUR could be expected to rally and breach the recent highs above 1.08.
Three-month EUR/USD movement:
Concerns about Brexit remain but the details will not be known for some time, even after the likely triggering of Article 50 at the end of this month. Latest concerns include the possibility of another Scottish referendum being called. EU negotiators seem intent on establishing the UK bill for leaving the EU – which they have suggested is going to be in the region of £60bn – before any negotiations on trade deals can start. So it is hard to see any positive developments on this front in the near term, given the likely European preoccupation with elections. Meanwhile, the UK economic data has turned more mixed of late as the inflationary impact of the recent GBP decline has started to hit, and there is a risk GBP starts to suffer from a loss of economic confidence if this continues. The Fed decision is likely to be key for GBP/USD as well as other USD pairs, but it is hard to see GBP/USD rallying beyond 1.28 even if the Fed choose not to move, while a US rate hike is likely to put 1.20 under threat again.
Three-month GBP/USD movement:
The CAD came under some pressure at the end of February as the increased chances of a Fed move in March started to be priced in. The CAD may also have started to suffer from the perceived risk of the US tax reform including a border adjustment tax (BAT). With the US taking 75% of Canada’s exports, and exports to the US accounting for 4% of Canadian GDP, the risks to Canada and the CAD from a BAT are greater than for other currencies. Despite flirting with 1.30 in February USD/CAD hasn’t managed a convincing break and even if the Fed don’t hike, a break below 1.30 looks difficult while we await news on US fiscal plans. Upside risks towards 1.38 remain on a Fed hike, and news of a BAT could lead to a larger rise.
Three-month USD/CAD movement:
USD/MXN continued to edge lower through February after peaking in mid-January, but remains well above the pre-election level near 18.50. There is consequently more positive USD/negative MXN news priced into USD/MXN than most other pairs. The MXN will be less vulnerable to US rate hikes than other currencies, given the already big yield advantage established by Mexican rate rises last year, but will still be vulnerable to any US protectionist measures, if announced. However, in the absence of such an announcement, USD/MXN should remain biased lower, though there is strong support near 19.000. News on the US BAT is likely to be needed to push USDMXN back to the highs above 22.00.
Three-month USD/MXN movement:
Compliments of Banockburn – a member of the EACCNY