USD Strength, Employment Growth, Trump

US data continue coming in on the strong side, with yesterday’s NFIB small business optimism index reaching 105.8, well exceeding the 99.5 consensus expectations and accelerating sharply from the 98.4 November reading. Small business is inward looking and with this index rising to its highest level since 2004 it seems that animal spirits have come back to the US economy. Overcoming a balance sheet recession is fundamentally different from dealing with an inventory overhang-caused recession. Notably,a balance sheet recession sees capital expenditure staying weak for longer as corporates react to better demand indications by hiring into their work force instead of adding to their capital stocks. Most DM countries have experienced what we call a ‘monetisation’ of their capital stock,allowing the depreciation of the capital stock to exceed the replacement of investments. This capital stock monetisation allowed corporates to add to their cash flow and provide the foundation to engage in record equity buy-back programs.

At a certain point capital stocks reach a low point which is typically the case when the marginal costs of labour exceed the marginal risk adjusted cost of capital. The labour / capital ratio has increased since Lehman and with underinvestment and employment growth reaching an ever widening gap productivity declines. Surging small business optimism suggests that the US may now finally leave the post Lehman balance sheet consolidation recession behind,adding weight to our call suggesting the USD will rally. It is the US closing its output gap while others,especially AXJ, widening their output gap which suggest investment return differentials working increasingly in favour of the USD. All this happens when there are increasing signs of a international USD shortage as manifested by press reports suggesting Saudi Arabia tapping the USD market in February to cover for domestic fiscal deficits.

Some stumbling blocks for the USD to clear. While the big picture turns increasingly clearer helped by reports such as business optimism, there are still some stumbling blocks for the USD to clear before resuming its rally. The US consumer has sent out mixed signals with the December consumer climate indices as provided by the Conference Board and the University of Michigan showing pre-Lehman readings, but our in-house Alphawise Retail Tracker suggesting a retail dip in December. The US December retail sales report will be released on Friday and with the MS projection way below consensus we wait for the USD to dip before trading the USD aggressively from the long-side again.

Trump will b etalking. Today the focus will be on the content of President-elect Trump’s press conference (16.00 Ldn).From a currency perspective, markets will aim to get a clearer picture on trade, fiscal stimulus and the new administration’s relationship to the Fed. Recent press reports leave the impression that corporate tax reform in conjunction with a border tax adjustment may have a better chance of finding stronger support with the GOP and hence has a better chance of implementation. Should Trump hint at something in this direction the USD is likely to move immediately higher. The USD would rally against commodity currencies as the border adjustment tax may not bode well for global trade.

Trump supporting measures allowing the US to export more energy combined with a border adjustment tax may provide a substantial boost to US energy exploration and production. Consequently, the US, which is currently the globe’s third largest oil producer, could add to global supply. International oil prices would fall. China will listen. China’s Security Times suggested China may seek retaliation should the US erect a trade barrier. Concretely, the paper threatened to “cancel orders from Boeing, disrupt Apple’s supply chain or even impose higher tariffs on imported agricultural products from the U.S.” Hence,any talk about serious trade restriction plans will not bode well for global risk appetite. The USD rally would move from turning a low-yielding currency event towards a high-yielding currency event. Commodity FX should fall most should the designated US President focus on trade. A different market reaction should occur should fiscal policy expansion make the headlines. In this case,a rising USDJPY would be the best game in town.