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US dollar on course for worst week since May: here’s why

The buck is on course to notch its biggest weekly slide in almost four months, with investors turning increasingly bearish on the American economy, the potential for rate increases and the Trump administration’s ability to deliver stronger growth.

The dollar index, a gauge of the greenback against six major trading partners, has fallen 1.7 per cent this week to 91.26, the biggest fall since mid-May. It has tumbled 12.1 per cent since its post-US election high of 103.82 that was hit in early January, FactSet data show.

Themes that many market analysts expected to drive the dollar higher in 2017 have played out differently than they had expected, instead pressuring the buck. The currency fell for the sixth consecutive month in August – the longest slide in 14 years – and the decline has not stopped in the early days of this month.

Kit Juckes, strategist at Société Générale, said there are “two underlying drivers of dollar weakness”:

The first is that the peak in US growth and in expectations about the likely peak in the fed funds rate and the economic impact of President Trump are all behind us. The second is that the rest of the world hasn’t been standing still.

On the domestic front, gross domestic product is expected to expand 2.2 per cent this year, with the rate holding essentially steady over the following two years, according to the median estimate of economists polled by FactSet.

Hope that Donald Trump will be able to push pro-growth measures like corporate tax reform or a large spending programme has dimmed markedly. The president is fighting controversy on several fronts, and this week forged a deal with Democratic lawmakers in Congress over a short-term debt ceiling suspension, something that infuriated leaders in his Republican party.

After news of the pact broke, Alec Phillips, political economist at investment bank Goldman Sachs, reduced his forecast for the odds of tax legislation being passed next year to 40 per cent from “slightly better than even.”

Looking at the political issue from another angle, analysts at M&G Investments also note that the dollar has tended to fall in line with Mr Trump’s approval ratings.

Perhaps even more importantly, Wall Street has had to trim its expectations for Federal Reserve tightening this year. The probability assigned to a third Fed rate increase in 2017 has fallen to 29 per cent, from almost 44 per cent a week ago, according to calculations by the CME Group that are based on federal funds futures.

“With the negative economic effects of Hurricane Harvey (and now Irma), North Korea-related geopolitical tensions and what remain lacklustre US inflation dynamics seeing odds of another rate hike this year tumble,” said ING strategist Viraj Patel.

“Indeed, we may require a mighty turnaround in US data over the coming months to convince the [Federal Open Market Committee] to raise rates in December.”

George Saravelos at Deutsche Bank adds that “this is not about whether the FOMC will raise rates in December but a broader question of what will happen beyond.” He said that changes in the membership of the central bank’s policy-setting board make it “impossible to identify the future policy path given that the nominees will be decided by President Trump.” In short, he wrote: “the dollar is in trouble.”

The decline is reflected in the yield on America’s benchmark 10-year note, which is now sitting on the precipice of 2 per cent for the first time since the day after Donald Trump’s election, down from 2017 highs above 2.6 per cent.

On the other side of the equation, the economies of significant trading partners are looking brighter. The eurozone in particular has been a focus, with output rising at the fastest pace since the currency bloc’s debt crisis. In turn, economists are now expecting the European Central Bank to begin outlining plans this year to begin unwinding its bond-buying programme.

The optimistic performance has sent the euro soaring 14.6 per cent on the buck this year. That has been bad news for the dollar index, with the common currency being weighted at 57.6 per cent, according to the Intercontinental Exchange, which manages the gauge.

Up north, Canada has also been looking stronger, overcoming the ructions caused by the 2015 tumble in the oil price. Its central bank has surprisingly lifted rates twice in the past three months, something that has sent the Canadian dollar rallying.

“Forces required to make the US dollar great again are falling by the wayside,” said Mr Patel, alluding to Mr Trump’s campaign mantra.