U.S. officials created a small firestorm with their dollar comments in the chilly air of Davos this week, but a much more important factor for the future of the currency will be what they say and do about trade when they leave Switzerland.
Strategists say the dollar could consolidate now after its latest bout of weakness, and the focus will now be on whether the Trump administration can pursue its goal of new, fair trade agreements without sparking trade wars and new currency volatility.
The dollar index has been in a year-long decline, defying forecasts that it should strengthen from the fact that the Federal Reserve is raising interest rates and normalizing monetary policy faster than its counterparts. But the opposite has happened, and the dollar weakened as flows increased into the euro and yen, as those economies improved, and central bankers in Europe and Japan look closer to removing their own heavy handed accommodation.
Then this week, U.S. Treasury Secretary Steven Mnuchin stirred the pot, with a possibly innocuous comment to journalists at the annual World Economic Forum about dollar weakness being good for U.S. trade. To markets, that sounded like a not very subtle endorsement of the falling dollar and a step away from the long-running U.S. policy of verbally supporting a strong dollar. The comment also took on more significance since it was made at the Davos confab, dubbed the 'epicenter of globalization' by one strategist.
"The dollar had a terrible start to the year way before Mnuchin came in and made those comments. The trend didn't come from that, so we obviously had some volatility down and up this week on the back and forth from that. I don't think the trend is about that. It's about global growth, about the shift in some capital flows, such as Chinese capital flows, and that's separate from whatever that one sentence comment was that was made by Mnuchin and others," said Jens Nordvig, CEO of Exante Data.
Mnuchin's comments also came just as the U.S. launched trade sanctions against Chinese solar panels and South Korean washing machines. Crucial trade talks were also underway this week in Canada, as the U.S., Mexico and Canada try to reshape the 24-year-old NAFTA agreement. The Treasury secretary's comments triggered not so subtle criticism from Europe's central bank head Mario Draghi about unnamed officials talking down their currency.
Mnuchin and later President Donald Trump tried to walk back the weak dollar comments. Trump triggered a temporary rally in the dollar Thursday, when he said on CNBC that Mnuchin's comment was taken out of context and the dollar should get stronger with the U.S. economy. On Friday, Mnuchin, also on CNBC, used some of the exact language of his predecessors—that a strong dollar was in the "best interests" of the country.
But the market continues to sell the dollar, and some strategists expect that to continue this year, even after a period of possible consolidation. The dollar index touched a new three-year low Friday.
It could accelerate if Trump takes broader trade actions that are seen as protectionist.