By Joseph Adinolfi, MarketWatch
Stop me if you’ve heard this one before.
Goldman Sachs has proclaimed going long the dollar as its top trade for 2017, a decision that might revive unpleasant memories for some of the bank’s clients. Specifically, the bank is recommending investors use the greenback to bet against the euro and British pound.
The storied investment bank made a similar call last year, advising its clients to bet that the dollar would rise against the euro and yen. That trade turned out to be a disaster for anyone who took the bank’s advice, as the yen appreciated rapidly in January, sinking the dollar, following the Bank of Japan’s decision to impose negative interest rates on some deposits. By mid-February, the bank had closed out the long-dollar call. The powerful bank’s calls, and their reversals, get a lot of attention. Describing its reach in 2009, a Rolling Stone article likened the investment bank’s reach to “a great vampire squid.”
Goldman’s top currency strategists have long held on to their view that the dollar will appreciate past the point of parity against the euro, standing by their call even as the Federal Reserve’s reluctance to raise interest rates weighed on the U.S. currency in 2015 and 2016. Goldman argued that the central bank was still miles ahead of its peers in Europe and Asia when it comes to normalizing monetary policy, and that the market would eventually price this in once the Fed turned decidedly hawkish.
This time around, Goldman reasons that President-elect Donald Trump’s plans for tax cuts, infrastructure spending, protectionism and immigration controls will, if implemented, drive up inflation, causing monetary conditions to tighten and the dollar to appreciate.
Moreover, uncertainty surrounding the terms and timing of the U.K.’s exit from the European Union are likely to weigh on the pound, while a smattering of political risks — including a December constitutional referendum in Italy, as well as elections in France, Germany and the Netherlands next year — will dent the euro.
Undergirding all of this is the old monetary policy divergence theme. Many expect the Fed to quicken the pace of interest-rate hikes if Trump’s infrastructure spending plan becomes a reality. Markets are already pretty confident that the Fed will move on its second rate hike in a year by twisting the policy dial a quarter-point next month.
The biggest risk to this trade, in Goldman’s view, would be a premature tapering of the European Central Bank’s bond-buying program. However, Goldman believes this is unlikely, given the political risks mentioned above.
Goldman’s strategists expected Democrat Hillary Clinton to prevail in last week’s presidential election. To be fair, so did everyone else.
For its second top trade, Goldman recommends betting against the Chinese yuan by using a 12-month dollar-yuan non-deliverable forward.
The bank believes that to keep the yuan steady against a trade-weighted basket, the People’s Bank of China will need to allow it to weaken against the dollar.
The dollar strengthened against the euro /zigman2/quotes/201334960/delayed CA:EU +8.13% , pound /zigman2/quotes/210561263/realtime/sampled GBPUSD +0.1121% and the yuan /zigman2/quotes/210561991/realtime/sampled USDCNY -0.1146% , also known as the renminbi, on Friday. The dollar rose 0.5% to ¥110.74. It was up 0.2% to 6.89 yuan. The euro slid 0.2% to $1.0590.