Dollar up sharply as markets prices in tax stimulus, Federal Reserve hikes

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11 December 2017

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 US Dollar was the clear winner among G10 currencies last week. Markets reacted to the news that the Senate had managed to pass a version of the tax bill over the weekend, increasing the likelihood that a final version would be agreed to before year end. The consequence was a continuous widening of interest rate differentials which dragged the Dollar sharply higher against every other G10 currency.

T
he greenback also rallied last week against every major emerging market currency with the exception of the South African Rand and the Turkish Lira. The latter put in an exceptional performance and was by far the winner of the week, pushed higher by developments in the US trial of Raza Zarrab and hawkish rhetoric from the Turkish central bank.

This should be a volatile week for foreign exchange markets, jam packed with major central bank meetings. The Federal Reserve, the ECB and the Bank of England all meet this week. We should end the week with a clearer view of the prospects for further tightening of monetary policy in the US and the UK.

Major currencies in detail

GBP

The Pound received some help from news that the UK and the European Commission had agreed to move Brexit negotiations to the next stage where trade will be discussed, after reaching agreement in principle over EU citizens in the UK, the UK divorce bill and the status of Irish border. Cable did not move much on news of the agreement, a clear case of ‘buy the rumor, sell the news’. However, it did put in a creditable performance against the Euro.

All eyes are now on Thursday’s Bank of England meeting. Policy is expected to remain unchanged. However, MPC communications will be critical for the direction of Sterling into year end. In particular, any sign that dovish members Ramsden and McCafferty have softened their opposition to further hikes could significantly boost the Pound.

EUR

Germany released some softer than expected industrial production numbers, which probably added marginally to the selling pressure on the Euro. However, these don’t change in any way the view that the Eurozone economy is picking up steam, albeit without generating any inflationary pressures.

As in the UK, the focus this week will be on Thursday’s central bank meeting, and particularly the Council communications, as no change in policy is expected there either. The key will be the ECB’s update to its macroeconomic forecasts, specifically the revision to its inflation expectations after the disappointing core inflation readings of the past couple of months.

USD

The US employment report for November was in line with recent macroeconomic reports. Headline numbers were stronger than expected, but wage pressures are not yet picking up.

This mix of reasonably good growth and absence of clear inflationary pressures should be sufficient to warrant a 25 basis point hike Wednesday, and gradual hikes thereafter. Markets are slowly adopting his view, and the resulting upward pressure on US short term interest rates should keep buoying the US Dollar into next year. As in the ECB’s case, the most relevant outcome of this meeting will be the Fed’s expectations for future growth, inflation and rates.