Dollar’s post-election low is supportive for stocks and commodities
U.S. consumer credit expected to remain weaker
Weekly EIA report
Dollar’s post-election low is supportive for stocks and commodities — The dollar index after the U.S. November 2016 election shot up to a 14-1/2 year high by early January 2017 on expectations that the Republican election sweep of the White House and Congress would mean a strong growth agenda involving reduced regulation, tax cuts, and a big infrastructure program. However, the reality has been much different and the dollar index has since fallen by -7.0% to post a new post-election low on Tuesday.
The dollar index has fallen mainly because of disappointment that the Republican agenda has not yet translated into tangible results. The Obamacare repeal is currently hung up in the Senate. On tax reform, Congressional Republicans are waiting for the White House to provide a detailed tax reform plan that Republicans can perhaps coalesce around. The House version of tax reform is all but dead because its two main revenue raisers–the border adjustment tax and the end of the business interest deduction–have already been largely shot down by the White House and some Republican Senators.
We expect Republicans to eventually produce a tax bill, but it is likely to be much smaller than their initial ideas. On infrastructure, Congressional Republicans are likely to at most give the White House a small face-saving program that doesn’t cost much money and that doesn’t significantly boost the budget deficit.
The dollar has also been hurt since January by reduced expectations for Fed rate hikes and the decline in U.S. interest rate differentials. The decline in expectations for Fed rate hikes can be best seen in the Dec 2018 federal funds futures contract, which represents the market’s expectation for what the average federal funds rate will be during the month of Dec 2018. The Dec 2018 fed funds contract after the election rallied by a total of +89 bp from 0.93% before the election to the peak of 1.82% in mid-March. However, that contract has since fallen by -33 bp from the peak to 1.49%, reflecting market expectations for only 1-1/2 more rate hikes (after next week’s expected rate hike), far below the Fed-dot forecast for 4 more rate hikes by the end of 2018.
Treasury yields have also fallen substantially since January, undercutting the dollar’s interest rate differentials. The 10-year T-note yield has fallen sharply by -49 bp to the current level of 2.15% from the 2-1/2 year high of 2.64% posted in mid-December 2016.
The decline in the dollar index can also be tied in large part to strength in the euro, as opposed to just dollar weakness. The euro is currently seeing some strength based on the revival of the Eurozone economy, which grew by +2.0% (q/q annualized) in Q1, outperforming U.S. Q1 GDP growth of +1.2%. However, the euro is mainly seeing strength because the ECB is moving towards ending its extraordinary monetary policy measures. The consensus is that the ECB in September will announce the tapering of its QE program during the first half of 2018 and will start raising interest rates by late 2018. The markets know that the bulk of the dollar’s gains in late-2014 and early 2015 came as the Fed was tapering its QE3 program, not later when it started raising interest rates. Traders are anticipating a similar QE-tapering rally in the euro.
While the dollar index has seen a fairly steep decline since January, it remains within its 2-1/2 year consolidation range at the top of the 2014/15 rally. We believe that longer-term bull market for the dollar remains in place and that the dollar’s 2017 weakness is only a temporary correction. The dollar’s downside correction may have farther to go since the euro could see continued strength as QE tapering gets closer. Nevertheless, we believe the dollar index still has strong long-term support from the Fed’s multi-year rate-hike regime, which it will pursue as quickly as it reasonably can. The Fed is also intent on starting to reduce its balance sheet later this year. The Fed is at least three years ahead of the ECB on its monetary policy cycle, which is likely to eventually revive the dollar bull market.
In the meantime, however, the dollar’s weakness this year has been providing a boost to stock and commodity prices. The weaker dollar seen since January has been a factor in driving the stock market to record highs since the weaker dollar means increased export sales and a higher value for repatriated earnings. The weaker dollar has also been a supportive factor for commodity prices, although commodity prices have nevertheless moved generally lower due to over-supply in many commodity markets.
U.S. consumer credit expected to remain weaker — The consensus is for today’s April consumer credit report to show an increase of +$15.0 billion, which would be mildly weaker than March’s +$16.431 billion. Consumer credit growth has downshifted to a monthly average of $13.3 billion in the first three months of 2017 from the much-stronger average of +%18.5 billion seen in 2016.
Weekly EIA report — The market consensus for today’s weekly EIA report is for a -3.0 million bbl decline in U.S. crude oil inventories, an unchanged level of gasoline inventories, a +750,000 bbl increase in distillate inventories, and an unchanged refinery utilization rate of 95.0%. U.S. crude oil inventories have fallen for 8 straight weeks by a total of -25.6 million bbls (-4.8%), which is a much larger decline than the usual seasonal decline that occurs as refineries ramp up operations to produce summer gasoline. U.S. crude oil inventories are now +24.8% above the 5-year seasonal average, which is still a serious glut but is much better than the +40.7% above-average level seen as recently as February. Meanwhile, U.S. oil production last week rose by another +0.2% to a new 1-3/4 year high of 9.342 million bpd. U.S. oil production is up by +643,000 bpd (+7.4%) since the Nov 3, 2016 OPEC production-cut agreement.