Dollar rally picks up steam on US economic strength

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21 November 2016

Auteur
Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.

The relentless rally in the US Dollar actually sped up last week, as the greenback broke to its highest level since 2002 in trade-weighted terms.

L
ast week’s surge was notable in that it took place even though the global emerging market sell-off actually eased back. Strong economic news out of the US and increasingly hawkish commentary from Federal Reserve officials are reinforcing the two underlying themes for Dollar appreciation since the Presidential Election: faster growth and higher rates in the US.

Figure 1: Market Implied Probability of December Fed Rate Hike (2015 – 2016)

Another key feature of last week’s price action was the strong rebound in commodity currencies, led by the Mexican Peso, Russian Ruble and Brazilian Real. The move took place even though we saw little upside in commodity prices themselves. Perhaps this is a sign that the brunt of the post-election sell-off is over.

Political developments will continue to drive financial markets in the coming weeks, but now the focus shifts from the US to Europe. US markets go into the traditionally quiet Thanksgiving week.

News from the French Republican party primaries, the Autumn Statement in the UK from Chancellor Philip Hammond and expectations ahead of the Italian December referendum will take centre stage in a week relatively short on major economic data or policy news.

Major currencies in detail:

GBP

On Wednesday we should get further clarity on the UK Government’s post-Brexit fiscal stance.

Markets generally expect larger budget deficits in the future on the back of higher inflation and unemployment. The key will be whether additional discretionary spending is announced. If so, the combination of higher rates and higher growth from fiscal stimulus could work a similar effect on the Pound as what we have seen in the US after Trump’s election.

In that case, and given the still massively stretched short position on Sterling among investors and traders, we could see a significant rally in Sterling.

EUR

All the European data last week came out roughly in line with expectations: GDP growth (sluggish), industrial production (barely growing) and inflation (way too low).

Just matching these rather modest expectations is not sufficient to keep the common currency from falling, though.

This week, in addition to expectations ahead of the upcoming Italian constitutional referendum, where the No vote appears to have built a steady lead in the polls, we get the leading PMI business sentiment indicators. Consensus is for a largely unchanged reading, at a level consistent with the current sluggish growth environment. It will be interesting to see if the US election shock has had any impact on business executives’ confidence.

USD

The US Dollar was buoyed last week by an excellent retail sales report and a massive upward spike in home building.

We have been calling for such a rebound for some time; the pace of homebuilding in the US has failed to keep up with population growth and household formation ever since the 2008-9 housing crash. Clearly, any fiscal stimulus from the Trump administration will hit an economy that is already doing quite well and nearing full employment.

Federal Reserve hawkishness has only added to the upward pressure on the Dollar and the likelihood of a December interest rate hike is now being priced in by the markets at nearly 100%.

There are not many economic announcements this week, which is shortened by the Thanksgiving holiday. Perhaps most important will be the publication of the minutes of the FOMC November meeting. We are very eager to find out the reasoning behind the increase to the inflation forecast. Any sense that the FOMC is starting to worry about upside risks to inflation could fuel a further Dollar rally.

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