Currency investors are showing that expectations that Donald Trump's policies would boost the U.S. dollar might be running out of steam.
The dollar took off in the wake of Trump's surprise election in November, but since the start of the year, it has begun to drop off. The dollar, as measured against a basket of foreign currencies, rose about 6% from Election Day to January 3, when it peaked, and has slipped about 4.5% since then. It fell again on Friday morning in anticipation of the House Republicans' health care vote. Just as equities markets appear increasingly doubtful of Trump's earnings-boosting promises, so are currency investors taking an equally dubious attitude.
"The problem for the dollar has been that the wait's gone on, the market's sitting there with fairly sizable long-dollar positions anticipating lots of good things, and those good things haven't arrived," said Steven Barrow, head of G10 Strategy at Standard Bank. "So some people in the market are bailing out and questioning whether it's right to hold the dollar up at these very lofty levels."
In the same way that Trump's promises of tax reform, deregulation and infrastructure investment drove stock markets higher after the election, his pledges and those of Congress inspired confidence in the dollar as well -- at least initially.
The president ran on a platform to enact a 10% repatriation holiday on corporate profits held abroad. If enacted, many believe the holiday would support the dollar by creating an inflow of money back into the United States, Barrow said.
Another dollar-buoying element would be the border adjustment tax, which taxes imports and exempts exports and is part of the House Republicans' tax blueprint. The theory at the heart of the measure is that it will balance itself out through exchange rates and result in a stronger dollar.
Neither measure appears close to coming to fruition. Trump and Congressional Republicans are dead set on enacting health care reform before they move on to taxes, and if and when they get to it, the border adjustment tax is no guarantee. Unless Trump comes out in favor of it, most agree it is dead in the water. The House delayed its vote on health-care reform on Thursday amid signs that not enough Republicans would vote for it.
"Does the market have a sense that those kinds of promises are not going to be realized? I'm not sure," Barrow said. "Maybe it's just that Trump's obviously been bogged down with other issues."
Also in play is the Federal Reserve, which in March raised interest rates to 0.75% to 1% and is on track to raise them at least two more times this year. The Fed took a cautious tone in the wake of the rate hike, analysts at Natixis said in a note on Wednesday, which weighed on the dollar.
"The market expected the Federal Reserve's tone to be more hawkish given the stronger growth and employment, and since inflation accelerated to 2.7% in February," wrote Natixis analyst Nordine Naam. "Clearly, however, FOMC members have not modified their predictions of the Fed Funds rate and remain favorable to a gradual tightening."
According to an analysis from Bank of America reported by Bloomberg, bullish dollar positions put on after the election have disappeared.
"The dollar positions accumulated in the buildup and immediate aftermath of the U.S. election look to have been fully unwound," Bank of America strategists led by Myria Kyriacou wrote in a research note. "Positioning will not be the main driver of the next broad dollar move."
"What's been more of a magnet are the currencies that tend to go up when there's extra risks creeping into the market," said Barrow, pointing to the Japanese yen and the Swiss franc. The yen is up about 5% and the Swiss franc has gained about 2.5% since the first of the year, both heading the opposite way of the dollar.
The Peso Rebounds ... for Now
The Mexican peso was the hardest-hit currency in the wake of Trump's election. It fell 10% from Election Day to the end of 2016 and about another 5% during the first two weeks of the year. The Mexican central bank intervened at the start of the year to stop the peso's skid as investors grew increasingly concerned over Trump's rhetoric towards the country and his pledge to renegotiate the North American Free Trade Agreement.
In recent week and months, however, the tide has turned -- the peso has climbed around 15% since Trump's inauguration.
"It's been a steady strengthening of the peso for different reasons," said Alfredo Coutino, Latin America director at Moody's Analytics.
After a dustup over who would foot the bill for a wall at the Mexican border that resulted in a cancelled meeting, President Trump and Mexican President Enrique Pena Nieto reached a mutual agreement to refrain from discussing the matter in public. "Since then, we have heard less from Trump about that particular point, which is important for the peso," said Coutino.
Trade negotiators have sent positive signals on the future of Nafta as well. Secretary of Commerce Wilbur Ross, who will have as one of his primary tasks Nafta renegotiations, spurred a jump in the peso in early March with comments that the currency would "recover quite a lot" if the U.S. and Mexico reach a "sensible" trade agreement.
"We also need to think about some other mechanisms for making the peso-dollar exchange rate a bit more stable," he said.
The Mexican government has also implemented an additional monetary instrument to defend the peso that serves as a hedge. It has also played a role in pushing the peso into positive territory.
Still, the peso is still trading lower than it was on the day of Trump's election and is down about 8% against the dollar from where it was a year ago. Moreover, just because Trump has ratcheted down his rhetoric at the moment doesn't mean it will last forever.
"It's positive for Mexico; however, I would take that with reserve and just keep an eye on what is going to develop when Nafta negotiations start," said Coutino. "It wouldn't be a surprise if the peso depreciates again."
-- Updated with dollar's Friday decline.