Amid the recent ramp-up in US-China trade tensions, market observers wouldn’t have been faulted for expecting the Dollar to rise on the wings of risk aversion. Instead, in the days leading up to May 10 when US tariffs were more than doubled to 25 percent on $200 billion worth of Chinese imports, the Dollar index continued weakening towards the 97-support level. As uncertainties re-emerge surrounding US-China trade talks, it appears that the Japanese Yen is raining on the Dollar’s parade, given that the JPY holds the second biggest weightage on the DXY at 13.6 percent, at time of writing. Markets latched on to the Yen’s safe haven status in the week of the US tariff hike, as USDJPY declined by over one percent to register its steepest weekly drop in seven weeks and fall below the 110 level.
Taking a longer-term view, the Dollar index should still have enough reasons to build on its year-to-date climb. From a fundamental perspective, the US economy has been churning out above-trend growth, as further evidenced by the 3.2 percent GDP in the first quarter. The US jobs market has added on average 169,000 jobs per month so far this year, while unemployment reached its lowest level since 1969, implying that US consumers can keep growth momentum going.
Although the US growth trajectory is expected to moderate over the course of 2019, it’s still set to outperform the European Union; a base case that should be supportive of more Greenback gains given that the Euro accounts for more than half of the Dollar index. The European Commission again reduced the Eurozone’s growth forecast to 1.2 percent for 2019, as the impact from persistent US-China trade tensions are already being felt on the continent.
Also recall earlier in May, the Fed expressed no bias towards adjusting its monetary policy settings either way for now, while expecting the subdued US inflation picture to be “transitory”. US interest rates staying at current levels could serve as a platform for the Dollar to rise further.
However, the market’s immediate focus appears centred on US-China trade negotiations, which could still produce more drama for the markets. Keep in mind that China has said it will have to undertake “countermeasures”, even as US trade negotiators reportedly gave China a month to seal a trade deal or risk having tariffs imposed on all of its products shipped to America. Note that President Donald Trump could still roll out a 25 percent tariff “shortly” on a separate $325 billion worth of Chinese goods. Such posturing has dealt a blow to risk appetite, as investors grow wary of heightened barriers to global trade and its implications on global growth.
In short, should US-China trade tensions rise further, so too could the Japanese Yen. As a result, DXY bulls may have to work harder to keep the Greenback’s upward trajectory intact in the weeks ahead.