By Joseph Adinolfi, MarketWatch
The rise of European populism
While the contrasting monetary-policy stances of the ECB and the Fed are perhaps the most significant drivers of this trade, “political uncertainty,” as it’s known in the argot of finance, might run a close second.
The U.K.’s vote to leave the European Union and the Italian government’s failure to successfully sell a slate of proposed constitutional reforms to the public have stoked fears about the gathering influence of euroskeptic populism.
Populist parties appear poised to accumulate more political clout as Germany, France and the Netherlands are holding general elections. Polling would suggest that France’s Marine Le Pen has a shot at becoming the next president of France.
Should she win the vote, Le Pen has promised to hold a referendum on EU membership. While significant gains for populist parties in Germany and the Netherlands would probably weigh on the shared currency, “the French election is the biggest threat [to the euro],” said Naeem Aslam, chief market analyst at ThinkForex.com.
Aslam believes Le Pen will win.
The Trump effect
The dollar has rallied sharply since the Nov. 8 U.S. presidential election, when President-elect Donald Trump upset Hillary Clinton. Market strategists have largely attributed the greenback’s rapid appreciation to Trump’s proposed policies, notably corporate tax cuts, a massive infrastructure spending bill and protectionism.
Should they be implemented, investors expect that his policies, particularly the infrastructure spending bill, will stoke growth and lift inflationary pressures.
Rising inflation could force the Fed to raise interest rates with more gusto, while also driving Treasury yields /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y 0.00% higher. The dollar has a longstanding positive correlation with Treasury yields.
However, some strategists have warned that the market might be getting ahead of itself. Even if Trump succeeds in pushing his proposals forward, it could take years to filter through to the underlying economy—and that could spark a reversal of the Trump-inspired moves across asset markets, said James Swanson, chief investment strategist and portfolio manager at MFS Investment Management.
“To ramp up government spending to any material degree is a two-to-three year process at best,” Swanson said.
To be sure, if the dollar’s performance over the past two years has taught Wall Street anything, it is don’t count your chickens before they hatch.
“Former Bank of England Governor Mervyn King once said that you have to be mad to forecast foreign exchange rates such is the unpredictability of currencies,” said Steven Barrow, head of G-10 strategy at Standard Bank in a recent Wednesday note.
“We’d go along with that.” Barrow adds.