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Tokyo - Currency traders have long been used to analysing political risk - just not so much when it comes to the US dollar.
The greenback has been rattled this week by political concerns, spurring debate over the long-term implications of Trump administration policies and their impact on demand for assets denominated in the world’s reserve currency.
It’s a relatively unfamiliar dynamic for those accustomed to looking at bond-yield differentials when attempting to gauge the dollar’s outlook.
"I’m not sure serious analysis is possible, and I don’t trust my gut instincts on something as far from the usual state of affairs," said Kit Juckes, a global strategist at Societe Generale in London and a veteran of more than three decades of market research.
Juckes was referring, in a note Tuesday, to the dollar’s reaction to President Donald Trump’s selective travel ban.
While the dollar index is still higher than before the November 8 election, it’s the foremost example of a "Trump trade" running out of steam in recent weeks.
The S&P 500 Index of stocks remains near a record following an initial surge of optimism over Trump’s economic reflation program, and US Treasuries are little changed over the same period.
The big question for traders now is to what extent political risk will drive the dollar’s prospects, given the spectre of a rising sovereign risk premium and protectionist policies that may test the appetite of official-sector investors to finance the US deficit.
Watch the flows
Among gauges to monitor: the US Treasury’s monthly report on international demand for US assets, with the next one due February 15, for December.
The Federal Reserve reports weekly on its custodial holdings of Treasuries for foreign official and international accounts.
Over a much longer time frame, the International Monetary Fund’s quarterly data on reserve assets would show any shifts in the dollar’s dominance.
Another x-factor: jawboning by Trump administration officials in favour of a weaker exchange rate. The greenback took a leg lower on Tuesday after published remarks by a Trump adviser blasting a “grossly undervalued" euro.
"Policy uncertainty coming from a country that (1) is the biggest importer in the world and (2) the biggest external borrower in the world ought to be consequential," said Stephen Jen, London-based chief executive of hedge fund Eurizon SLJ Capital.
A focus on borrowing needs could send the dollar lower for a short period, he said.
'Not patriotic'
Even so, at the end of the day, "capital flows are not patriotic," and the US yield premium will lure global investors, Jen said. Also: "If things turn sour, US Treasuries remain the best safe haven in the world."
The dollar’s status as the main global reserve currency, and the appeal of Treasuries as the largest and most liquid government-bond market in the world, saw it climb during the throes of the global financial crisis.
The scramble for dollars eventually prompted the Fed to open multiple swap lines with counterparts overseas.
American assets have withstood assaults before. The sovereign-rating downgrade of the US by S&P Global Ratings in 2011 briefly roiled financial markets so much that the Group of Seven put out a statement to calm things. In the end, the impact was short lived.
The dollar had a more lasting down trend during the early years of former President Bill Clinton, on perceptions his administration was seeking a weaker domestic currency and amid a focus on the widening US trade deficit.
The scenario of protectionism crimping the greenback is one that’s already been making the rounds among traders.
Unanticipated political developments may make traders pine for the relative certainty of economic indicators and central bank policy statements – on Wednesday’s Fed decision and Friday’s non-farm payroll report are at least scheduled events.
"My bias is still that we’ll get back to the Trump economic program, and the implications for Fed policy, before too long," said Juckes at Societe Generale.
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