Far too early to call time on dollar’s three-year recovery

Mr Trump’s proposed expansionary fiscal policies should provide a boost to growth over the medium-term, writes Oliver Mangan.

US president Trump has inherited a very strong economy. Data shows that real final domestic sales — GDP minus net trade and changes in inventories — which offers the best picture of the domestic economy, rose by 2.5% year-on-year in the fourth quarter of last year. It grew by 2.1% in the third quarter and 2.4% in quarter two. Thus, the underlying growth rate in the US has been very stable at a solid 2%-2.5% in recent quarters.

Consumer spending continued to increase at a strong pace in quarter four, adding 1.7 percentage points to GDP. Private investment made a third consecutive positive contribution. Inventories also continued to rebound following a period of contraction.

Meanwhile, the US labour market continues to perform strongly. Non-farm payrolls rose by 1.2m jobs in the second half of last year and a further 227,000 in January. The unemployment rate has averaged a very low 4.7% in the past three months.

Despite this, the pace of wage growth has remained moderate. Year-on-year growth in the wages component of the Employment Cost Index, the Fed’s preferred earnings measure, slowed slightly to 2.3% in quarter four, from 2.4%. Meanwhile, average weekly earnings rose by 2.5% year-on-year in January.

Headline CPI inflation has been on an upward trend, rising to 2.1% in December, its highest since June 2014. It has been boosted by higher oil prices. However, the Fed’s preferred measure of price pressures, core-PCE inflation, held in a 1.6%-1.7% range throughout 2016, remaining below its 2% target. Thus, inflationary pressures remained well contained.

Survey data on the economy for January point to continued solid growth. The Composite PMI rose to 55.4, its highest level since November 2015. Both the Michigan and Conference Board measures of consumer confidence remained at high levels. Overall, the outlook for the US economy remains positive.

Mr Trump’s proposed expansionary fiscal policies should provide a boost to growth over the medium-term. The OECD recently estimated that his proposals could boost GDP by around 0.4 percentage points in 2017 and 0.8 percentage points in 2018. Both the IMF and OECD see the US economy growing by 2.3% this year, with stronger growth likely in 2018. It is questionable whether the US economy needs a fiscal boost at this time, with the jobless rate already below 5%.

His fiscal policies are also clearly going to impact the Fed’s decision-making on interest rates. The first Fed meeting of 2017 was held last week and concluded as expected, with no changes to monetary policy. It avoided giving any indication on the likely timing of its next rate move, but there was nothing in the post-meeting statement to suggest that the Fed is inclined to alter its expected path of rate increases.

The most recent set of projections on the likely path of interest rates were released at the December Fed meeting. The median projection for rates at the end of 2017 was 1.38%, which would imply three 25 basis points rate hikes this year from their current level of 0.63%. The Fed anticipates rates rising to 2.17% by the end of 2018 and to 2.88% by the end of 2019. Such rate increases would reignite the dollar rally, which has lost momentum over the past month as the market awaits details of Mr President Trump’s fiscal plans. A large gap would open up between rates in the US and elsewhere, propelling the dollar higher.

Another thing that dollar watchers will be on the look-out for in the weeks ahead is any signs that Mr Trump plans to press ahead with his promise to lower corporate taxes to encourage US companies to repatriate funds currently held abroad. This would be very positive for the dollar. While it has lost some ground this year, it is far too early to conclude that its three-year-long rally is over. Mr Trump’s fiscal plans, if implemented, would re-invigorate the dollar.

  • Oliver Mangan is chief economist at AIB

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