Dollar Rallies: Fiscal Stimulus Spending, Rate Hike and Inflation Expectations

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The US dollar posted strong gains this week, at one point staying firm above the psychological level of 100, a resistance level that has been breached as the Dollar Index jumped to 101 yesterday. After the initial turmoil of the election outcome just a week ago, the US dollar maintained strong gains, led by market speculation that a Trump administration could see renewed spending to the tune of nearly $1 trillion, which has suddenly sent inflation expectations higher.

Trump had previously pledged to increase spending on infrastructure to boost the economy and also to bring the jobs back to America. The prospects of this led to rising inflation expectations which has eroded the bond prices and pushing the yields higher. The US 30-year Treasury took a breather after falling for nearly 5 consecutive sessions this week as yields rose above 3%. Meanwhile the short term treasury notes, the 2-year prices continued to fall as the yields touched an 11-month high, currently at 1.05%.

Yields on the 2-year: 1.05%
Yields on the 2-year: 1.05%

“The post-election consensus … is that an anticipated pick-up in government spending to fund infrastructure projects might entail the issuance of more debt and the rekindling of inflationary pressures,” said Samarjit Shankar, global markets strategist at BNY Mellon in Boston.

US economic data picks up steam

On the economic front, data this week from the US continued to support the prospects of a rate hike as the US economy is expected to have finished Q3 and started the fourth quarter on a sound footing.

Retail sales in the US rose 0.8% in October beating the consensus of a 0.6% increase by a strong margin. Previous month’s retail sales figures were also revised higher to 1.3% to show a year over year growth in retail sales at 4.3%. Excluding autos, retail sales rose 0.8% higher than the forecasts of 0.5% bringing the year over year increase in retail sales excluding autos and gas to 4.4%.

The only weak data point this week was US producer prices, which remain flat in October while consumer prices released on Thursday showed that consumer prices accelerated at the fastest pace in April. Headline inflation was seen rising 0.4% in October, according to data from the Labor Department. The increase in inflation came with gasoline prices rising by nearly 7%, pushing consumer prices higher. October’s headline print came after September notched a 0.3% increase. Core inflation excluding the volatile food components saw an increase of 0.1%, rising for the second straight month but considerably lower than forecasts of 0.2% increase.

Rate hike coming soon – Yellen

The Federal Reserve Chair, Janet Yellen testified to the Joint Economic Committee yesterday. In her prepared remarks, Yellen said that the Federal Reserve was close to lifting the fed funds rate “soon” as the US economy continues to create jobs at a healthy pace and a rise in inflation expectations. In her remarks, Yellen said, a rate hike “could well become appropriate relatively soon if incoming data provide some further evidence of continued progress toward the committee’s objectives.” She, however, maintained that the pace of rate hikes would be gradual.

US Dollar Index – Rises above 101

The strong gains made by the US dollar index which has surged by nearly 3.5% since November 7th, a day before the US elections.

Incidentally, the Bank of International Settlements, in a report released this week called the US dollar “the best barometer of global investor risk appetite and financial market leverage.” Hyun Song Shin, head of research at the BIS-based in Basel, Switzerland said that “when the dollar is strong, risk appetite is weak,” noting that there may be no winners from a stronger dollar.

The greenback has been rising steadily with the bullish momentum picking up steam as investors run with the expectation that the Trump administration will be announcing new fiscal stimulus spending plans which could see inflation rise sooner than expected.

On the technical chart, the 100 price level on the US dollar index is a psychological resistance that has managed to pin down the dollar since late 2015. Although the dollar index has managed to post a fresh 12-year high, this week’s close could potentially determine if the greenback will be able to continue with its bullish momentum.

US Dollar Index Futures (ICE): 101.275
US Dollar Index Futures (ICE): 101.275

With still another three weeks to go before the all-important December FOMC meeting kicks off, the question remains whether the dollar will manage to keep its gains while the current lift off in the greenback could potentially mean that a near-term correction is well overdue.

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