Natixis: Another week where the US dollar climbs higher
Posted: 22 November 2016 | Nordine Naam, Senior Forex Analyst, Natixis | No comments yet
Last week, the US dollar’s rise against the majority of G10 and emerging currencies continued, but it isn’t immune to downsides.
Last week, the US dollar’s rise against the majority of G10 and emerging currencies continued – with the DXY dollar index breaking above 101. Spurred by growing concerns that president-elect Donald Trump’s economic agenda may prompt rising inflation, the Federal Reserve (the Fed) is expected to tighten monetary policy under his presidency – which has only boosted the US dollar’s value.
While the president-elect’s economic programme remains unknown, the market expects colossal infrastructure spending to accompany cuts to both corporation and income taxes. If successfully implemented, such a plan would stimulate both US economic growth and inflation, provoking a rise in wages in particular. Meanwhile, Trump’s commitment to allow US companies to repatriate foreign profits could sporadically bolster the US dollar during his presidency.
Under these circumstances, the five-year/five-year inflation swap forward rate (a measure of inflation expectations) has risen sharply – prompting an upturn in US long interest rates. Indeed, the Fed’s chair, Janet Yellen, indicated that a hike could come “relatively soon” during her testimony to Congress last week. In turn, the probability a Fed Funds rate hike – as indicated by the Fed Funds futures market activity – has soared towards 96%.
That said, the market prices in only one interest rate hike during 2017 – not the three hikes that we anticipate – which means there is certainly upside potential. Indeed, given we see inflation rising as high as 2.6% in the mid-term, we believe the Fed will become more proactive than the market currently anticipates.
However, over the mid-term, the US dollar is not immune to downsides. Here, the market is wary of two factors; first, a number of appointees to Trump’s future administration believe a strong dollar penalises US competitiveness and, second, the possibility that Trump’s stimulus plan is unachievable on the scale initially proposed during the election campaign.
This week, we are keeping one eye on president-elect Trump’s further appointments to his transition team, a raft of US macroeconomic indicators (including durable goods orders, PMI, and new home sales), as well as Federal Open Market Committee (FOMC) members’ speeches.
All things considered, we believe the underlying trend will be a greenback appreciation – and sharper interest rate hike than currently anticipated before year-end will confirm this.
EUR: EUR/USD heading lower towards 1.05
Last week, the euro pulled back below 1.06 against the US dollar. During the short-to-mid-term, the single currency has been penalised by myriad European political risks, most notably Italy’s constitutional referendum on 4th December and France’s presidential election primaries.
Certainly, another hindrance for the euro is the prospect of a six-month extension to the European Central Bank’s (ECB) quantitative easing (QE) programme until September 2017. Furthering the QE programme – which is in response to both weakening inflation and the strain on long rates in peripheral eurozone countries – is likely to provoke capital outflows from the eurozone as investors seek higher yields.
This week, watch out for both November’s PMI figures and the German Ifo Business Climate Index. Given the discrepancy between the Fed and the ECB’s monetary policies, we see the EUR/USD continuing to fall towards 1.045 before year-end before heading towards parity during 2017.
JPY: USD/JPY heading higher towards 112
Last week, of all G10 currencies, the Japanese yen weakened against the US dollar the most, as the USD/JPY climbed towards 110.20 – above our 110 target.
As the market’s risk appetite has perked up, investors have been encouraged to square their long positions on the yen (as many as 11,000 contracts were squared), which has fuelled the yen’s correction.
Of course, long positions held by speculative accounts remain numerous (around 32,000 contracts), which suggests further upside for the USD/JPY, particularly if – as we predict – the Fed tightens its monetary policy during 2017.
What’s more, a US long-term interest rates upturn will likely trigger Japanese capital outflows towards the US – especially if Japan’s 10-year rate remains capped at 0%. Indeed, last week, as promised, the Bank of Japan (BoJ) intervened on the Japanese yield curve in order to prevent long rates from passing above 0%.
Under these conditions, our next short-term target for the USD/JPY is 112 – after which we see the pair rising in the coming months.
GBP: EUR/GBP heading lower towards 0.846
Drawing strength from the latest UK macroeconomic indicators, sterling has proven somewhat resilient –especially given October’s retail sales were up 1.9% month-on-month (MoM) when a 0.5% rise was the consensus.
On the back of such promising indicators, sterling appreciated against the majority of G10 currencies – the US dollar withstanding. As a result of the single currency’s weakness, the EUR/GBP set a 0.550 low and should begin heading towards our 0.846 target that was set last week.
The pound is expected to remain buoyant before the Supreme Court’s hearing in early December, when judges will decide to either uphold or overturn the High Court’s Brexit ruling.
Certainly, not only will sterling be penalised if the lower court’s ruling is overturned, but this will also give a greater mandate to hard Brexiteers to ensure Prime Minister, Theresa May, invokes Article 50 before 31st March 2017. However, if the Supreme Court upholds the decision to ensure a parliamentary vote is required to trigger Article 50, sterling will reap the benefits. Given the vast number of short positions currently held on the British currency, the pound’s accelerated climb will be bolstered by the market.
Of course, Brexit remains on the horizon, along with growing uncertainty around both France and Germany’s upcoming elections – which, we believe, may send the pound onto the back foot during Q1 2017.
CAD: USD/CAD on course towards 1.37
The Canadian dollar was the only currency to appreciate against the US dollar last week. Currently, the Canadian dollar has benefitted from subsiding concerns that president-elect Trump will seek to renegotiate – or even abolish – The North American Free Trade Agreement (NAFTA).
However, the key stimulus for the Canadian dollar has been the crude oil price rebound above US$47/bbl. This was spurred by the market’s anticipation that the Organisation of the Petroleum Exporting Countries (OPEC) will strike a production cut deal during their meeting on 30th November.
That said, there is the threat of downside for the Canadian currency in the short-term. Given many expect the Bank of Canada (BoC) to stay on the fence for some time when it comes to monetary policy – while the Fed appears ready to leap – a USD/CAD climb towards 1.37 will become more likely, particularly if OPEC’s production deal is shelved later this this month.