Dollar Revival at Risk on Trump's Tone in State of Union Address

(Bloomberg) -- Dollar traders are paying closer attention to this year’s State of the Union address for any sign of a ratcheting up in rhetoric from President Donald Trump.

The U.S. currency has picked up this month after being hurt by the longest U.S. government shutdown in history, prompted by Trump’s efforts to obtain funding for a wall on the border with Mexico. If the president chooses to escalate this issue in his speech later Tuesday, the dollar could be set to extend this year’s drop, according to Mizuho Securities Co. and Westpac Banking Corp.

Dollar Revival at Risk on Trump's Tone in State of Union Address

“There’s likely to be a nervous reaction -- weighing on Treasury yields and stocks -- if Trump just complains about Democrats and threatens another shutdown next week if they don’t agree to wall funding,” said Sean Callow, senior currency strategist at Westpac.

The Bloomberg Dollar Spot Index, a gauge of the greenback against its major peers, has risen 0.3 percent this week but is still down nearly 1 percent in 2019, following the shutdown and the Federal Reserve curbing expectations for further interest-rate hikes. Ten-year Treasury yields fell six basis points in January, the third monthly drop and the longest run of declines since 2017.

Both Morgan Stanley and Nomura International Plc see dollar weakness becoming a negative spiral if foreign investors lose faith in returns from dollar assets.

Options markets suggest Trump’s address, coming at a time of thin trading during the Asian day and Lunar New Year holidays, won’t spur a large sudden move in the dollar. One-week butterfly options, which show the perceived possibility of an outsized reaction, are trading at the weakest level since 2013 for the euro and at a one-year low for the yen.

“Typically the market would largely ignore the State of the Union but given the large uncertainties it is desperate for any piece of news it can get,” said Esther Reichelt, a currency strategist at Commerzbank AG.

For Mizuho, the market will be wary of Trump’s “obsession” with building a wall but the impact may be benign if he stops short of threatening another government shutdown, according to its chief foreign-exchange strategist Kengo Suzuki. The same applies for his comments on China, with the dollar having shown resilience to trade tensions.

“If Trump shows a hawkish stance but strikes optimism by emphasizing progress being made in trade talks, market impact will be limited,” Suzuki said.

©2019 Bloomberg L.P.