Trump was elected thanks to the decisive votes of the manufacturing states of the Midwest and Appalachia, hit hard by globalization and a strong dollar. Among the first tweets of the newly elected president was one about the excessive strength of the dollar. In the following months he understood who was mad at him. Not with the Japan, considered the closest and most loyal ally. Not with the China, at least after Xi Jinping, with his visit to Washington, managed to melt the ice that had been forming between the two countries (and after the renminbi began to appreciate against the dollar until it returned to the levels of October last).
Trump had it in for Europe and especially with the Germany, accused of unfair competition because of a grossly undervalued euro, as reflected in the eurozone's outrageously large current account surplus.
Macron was triumphantly elected thanks to the decisive contribution of a center and centre-right electorate who might have considered the Le Pen-style vote on immigration, security and the desire for change, but which in the end made the desire for a stable and secure currency (certainly safer than that franc to which Le Pen would have returned). The stronger euro, in the eyes of Macron's electors, is today the confirmation of the goodness of his choice.
In Germany Merkel intends to present itself to voters in September not only with a balanced budget, full employment and a still very solid economic boom, but also with the message that the choice of a shared currency has not led to inflation and debt mutualisation. Of course, the German elector, as a prudent saver who doesn't go much further than the current account in his investments, is not happy with the return on his portfolio, but with an appreciating euro he will feel more satisfied and confident. In Italy we are not used to feeling richer when the euro appreciates, but in Germany this sensitivity exists and creates satisfaction and consensus
Il Trump trade, in the first part of this year, distracted us from the fundamentals making us think of a formidable revival of the US economy through taxation. This relaunch has not yet taken place, while what we have actually seen in the United States is tired and listless growth, with three consecutive quarters below 2 percent and the prospect of a 2017 which, in the end, will not be much better than 2016. All in a context of full employment, which leads the Fed to keep its guard up and threaten higher rates. If growth were strong, higher rates would give strength to the dollar, if growth is instead colorless, the even remote possibility that the restrictive monetary policy will cause a recession makes the dollar riskier and less attractive.
The rise of the euro is not surprising for its occurrence, but for its arrival so soon. The reasoning of the market, until yesterday, was in fact simple and straightforward. Euro will recover when rates start to rise e Draghi tells us that rates will go up later (and maybe much later) that Qe will be finished. Since Qe will end at the end of 2018, the euro will rise starting in 2019.
The reality is evidently more complex. The central banks, which often move together, have decided that the time has come to take another step towards the normalization of monetary policy (the last agreed action was last September). America, Canada and (maybe) the UK have just raised or will raise rates soon. Europe, which wants to give Italy another year and a half of low rates, will do its part through the exchange rate. The stronger euro will have a moderately restrictive effect due both to the direct consequences on the trade balance and to the depressive effect on the European stock markets. The weaker dollar, on the other hand, will make it easier for the Fed to continue raising rates.
In the second part of the year we will therefore move between 1.15 and 1.20. The swings will follow the successes (or failures) of Macron and his labor reform. If in September we see the barricades in Paris and a weak reform, the euro will suffer. If, on the other hand, we see a historic defeat for the French union, the euro will strengthen.
They will also be important US macro data and the passage or otherwise of the health care reform in the Senate in mid-July (Health care reform would make tax reform easier). On the tax front, no one talks about the border tax anymore, which would have given a big boost to the dollar, but the passage of even a half-sized reform would still be a positive thing for the American currency (as well as for the stock market, of course).
Further help for the dollar could come from Trump's Fed choices early next year. Some of the candidates, like warsh, are positioning themselves as proponents of much more normal (and therefore much higher) rates than we have become accustomed to. Even Goodfriend and Taylor, although more cautious, go in this direction. If, on the other hand, Trump wants rates only slightly higher, the choice will fall on Cohn or one Yellen reconfirmed.
To those who have dollars and want to keep them (for diversification, prudence or simply because they don't want to take losses) we suggest not buying more and buying protection. To at least partially compensate for the loss it will be possible to open long positions in euros and short positions in yen (the yen could weaken against the dollar and in any case it does not have the carry costs that a direct short of the dollar has). Long Canadian dollar and short American dollar positions may also be considered, depending on the opportunities.
Up to now Macron has given more boost to the euro than to the European stock exchanges. The euro and the stock exchanges will have to get used to sharing the benefits of the new framework. The ongoing correction is a buying opportunity to be used with prudence, however, because valuations are high and because the higher volatility will lead to even better buying opportunities than this in the second half. To start rising again, the European stock exchanges will need a stabilized euro. Those who can do so could mitigate the risks by buying European stock exchanges with financing in dollars.
In this already challenging context, Yellen's recent reminder of the high levels reached by financial assets should also be kept in mind. The last time Yellen said this was in May 2015. That time the market stopped rising for 13 months and during this time he allowed himself two corrections.
