Why Trump Can't Afford to Intervene in the Dollar Affairs

Volatility wise, Thursday was a relatively quiet day in the forex market. USD/JPY extended its losses but the greenback recovered against euro, sterling and other major currencies. The rallies in the Australian and New Zealand dollars were the strongest with both currencies experiencing their biggest one-day rally in 3 weeks against USD. While there were no US economic reports released, the rebound in stocks supported the steadier price action. Better than expected Chinese trade also helped fuel the recovery in AUD and NZD.

The big story of the day was President Trump's comments on USD. In a series of tweets, he said, "As your President, one would think that I would be thrilled with our very strong dollar. I am not! The Fed's high interest rate level, in comparison to other countries, is keeping the dollar high, making it more difficult for our great manufacturers like Caterpillar, Boeing, John Deere, our car companies, & others, to compete on a level playing field. With substantial Fed Cuts (there is no inflation) and no quantitative tightening, the dollar will make it possible for our companies to win against any competition. We have the greatest companies in the world, there is nobody even close, but unfortunately the same cannot be said about our Federal Reserve. They have called it wrong at every step of the way, and we are still winning. Can you imagine what would happen if they actually called it right?"

Investors are worried that by expressing a preference for a weaker dollar, President Trump is hinting that he could order the Treasury to intervene in the currency. This would be similar to his actions last week where he called China a currency manipulator on twitter and a day later, the Treasury made the label official. Could President Trump devalue the dollar? Certainly. Just last month he said he "could do that in two seconds if I wanted," but any intervention could backfire.

President Trump will argue that by devaluing the dollar, he's making US exporters cheaper and foreign profits of American companies more valuable in USD terms.

But dollar intervention is a bad idea because it drives up prices, creates more volatility in the markets and makes the Fed's job more difficult. If Trump's primary goal is to pressure the Fed to cut interest rates further, he's accomplished that by escalating the trade war with China. Markets collapsed, global growth will slow and investors are looking for two more rate cuts this year.

If Trump devalues USD, stronger foreign profits could be offset by lower stock valuations and weaker demand at home.

Also intervention rarely works if it is not coordinated with the central bank. If the Fed sterilizes the intervention, the impact could be limited. If stocks crash, investors will flock to the safety of US dollars anyway.

If intervention move is aimed at leveling the playing field with China, the US can't afford to intervene because China has deeper pockets. The Chinese government has $3 trillion in reserves to prevent the currency from weakening. US intervention on the other hand is funded by the Exchange Stabilization Fund, which has a buying power of USD 100 billion. Trump could allocate more funds but that would require the approval of Congress.

Judging from the price action in the dollar today and the move in US stocks, investors are not worried about intervention risk. They feel that the chance is low because it is unprecedented and dangerous but Trump likes to buck convention and could find ways to push this through.

Pak-India border tension keeps local bourse under pressure

Despite prevailing India-Pakistan conflict the benchmark of Pakistan Stock Exchange inched up to close at yet another all‐time high of 41,464. Though, average daily traded volumes declined 33%WoW to 404 million shares. Top slots in volume ranking continued to be occupied by second tier scrips like: BOP, TRG, ASL, JPGL and BAFL. Leaders during the outgoing week included: HASCOL, AKBL, SHEL, BAFL and ASTL, while laggards were: LOTCHEM, EPCL, FATIMA, PTC and DAWH.

Key developments during the week included: 1) new deadlines set by the government for privatizing Pakistan Steel Mills and Pakistan International Airlines, 2) Chinese investors expressed keen interest in investing in troubled businesses in Pakistan, 3) IMF Mission Chief to Pakistan said that country’s foreign currency reserves have not yet reached a comfortable level, 4) China will help Pakistan in rehabilitation and expansion of its railway system starting with 1,700km Karachi‐Peshawar track at a cost of US$8 billion that is expected to be completed in 5 years and 5) China Petroleum Pipeline Bureau agreed to construct LNG terminal at Gwadar on EPC basis envisaging 700km pipeline (42‐inches diameter) from Gwadar to Nawabshah.

The market is anticipated to remain under further pressure in upcoming weeks as PTI’s sit‐in (starting 30^th Oct) is planned to immobilize the government until accountability of Prime Minister, Nawaz Sharif begin for his alleged inclusion in Panama Leaks. Though the border tension with India has eased in recent days, the risk of escalation continues to persist. While the market was driven by E&P sector recently in the wake of OPEC’s nod to output deal, oil price volatility till finalizing the deal (on 30^th Nov) presents further risk to the market.

Deriving strength from the uptrend in oil prices, the global commodity index rose by 3.4% MoM in Sep'16. In this regard, oil prices remained volatile, firming ground by the month end on OPEC's decision to cut output. Following on, while coal prices went up by 8.9%MoM owing to persistent supply pressures in China, steel prices, coal prices remained volatile due to re‐stocking of inventories by Chines mills. FAO Food Price Index was also up 2.9%MoM/10%YoY, going up steadily since Jan'16 supported by increasing sugar and dairy prices. Prices of commodities like urea and cotton remained sluggish on abundant supplies. Going forward, oil prices are likely to determine the trend in commodity prices where seamless completion of the output deal by OPEC in its Nov'16 meet can contribute further gains.

In order to revive the country’s dwindling exports, the GoP is considering certain amendments in the Textile Policy. While in FY14‐19 Policy the GoP has already lowered ERF and LTFF rates to 3.0% and 6.0% respectively, further proposed incentives in the form of increasing rebate (encouraging value‐added), in the range of 4‐6%, are being deliberated. In case the proposed incentive package is approved, the potential impact of the policy on textile sector is likely to be material. Remaining depressed for the most part of the year on account of continuous decline in exports, analysts believe the said incentive package (if approved) can rejuvenate interest in the textile sector.