A reversal or a dead cat bounce?

31 August, 2017

A reversal or a dead cat bounce?

The greenback weakness has been the primary focus in FX trading this year. On Tuesday, the dollar index fell to a 2.5-year low of 91.62, with losses exceeding 10% since the begging of 2017. The underperformance was a result of many factors, including the collapse of Trump trade, convergence in monetary policies, flattening U.S. yield curve and better economic prospects throughout the globe. 

The dollar found some support on Wednesday, after revised U.S. GDP figures showed that the economy grew 3% in the second quarter; the strongest pace in more than two years. Additional support came after the release of the ADP report, showing the U.S. private-sector added 237,000 jobs in August, a much better result than the expected 185,000.

Many traders are questioning whether the dollar has finally found a bottom, or will weakness continue to persist. In the short term, the answer will be determined by Friday’s non-farm payrolls report. After the ADP release, there’s a high probability that NFP will surprise to the upside. If we get a similar figure, it will be the third month in a row that the U.S. economy adds more than 200K jobs. However, wage growth has been the key missing ingredient in the employment figures, with very little growth shown over the past two years. Expectations are that we will see a 0.1% uptick for August, after being flat at 2.5% during the previous four months. A surprise in wage growth of 0.2% or above, will likely lead to the steepening of the yield curve and a further recovery in the U.S. currency.

On the longer run, the debt ceiling, tax reforms, and the trajectory of interest rates, will determine the direction of the U.S. dollar. S&P Global warned yesterday that a failure to raise the debt limit would be more catastrophic than the failure of Leman Brothers, and would push the U.S. economy back into recession. Although this might be little exaggerated given the past experiences, failing to raise the debt ceiling will undoubtedly have a negative impact on the economy. The 2013 government shutdown resulted in an estimated $24 billion in lost economic output according to S&P, so the longer the shutdown, the more severe the impact on the economy. Thus, the dollar will remain under pressure if the Congress didn’t come along within the next two weeks.

On Wednesday, President Trump made his much-anticipated speech on tax reforms. However, no details were offered beyond his willingness to reduce corporate taxes by 20%. Many economists believe that slashing corporate tax rate from 35% to 15% is an unrealistic plan and won’t get through Congress. If the President fails to deliver on tax cuts, his first year in Presidency ends without any significant legislative accomplishments, which is another reason why the dollar will remain under pressure.

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