Growth Outlook Supporting US Dollar
Following Donald Trump’s victory in the US Presidential Elections, the US Dollar has been on a strong surge, breaking out to fresh thirteen year highs as markets adjust their US outlook. Improved growth expectations due to easier fiscal policy have seen core yield curves rising in response to higher growth. Consequently, the core yield curve has steepened acutely whilst the appreciation in the US Dollar has occurred at its fastest rate since early 2015 as market increase expectations for a US rate hike. Indeed, Federal Reserve rate hike expectations for December have now jumped to over 90% from around 60% prior to the election results.
Trump’s Fiscal Plans Boosting US Yields
The key takeaway for markets from Trump’s election is that the expansionary fiscal policy he has proposed is expected to put upward pressure on US yields, steepening the curve. In this context, it seems reasonable to expect that the current USD move has further to run and that USD appreciation is likely to be a key theme in the new year.
US inflation expectations have responded favourably to Trump’s win as markets anticipate increased growth will cause rising costs. Under the new administration, there is an increased chance of more Hawkish Fed appointments being made in accordance with Trump’s tighter monetary policy bias.
Consequently, monetary policy divergence between the US and the rest of the G10 space is likely to increase. Among the likely divergence, the BOJ stand out as being particularly vulnerable with the bank broadly expected to maintain their current 10y yield target of 0%. A significant increase in yield differentials between Japan and the US as well as expectations of USD appreciation should drive Japanese investors to reduce their hedges on foreign bond purchases. A roughly 20bp increase in the 10y US yield should equate to around 1.5%worth of upside in USDJPY provided that the impact on the risk environment is neutral.
In this context, USDJPY is clearly a strong channel through which to express USD upside. The breakout above the bearish trend lien from late 2015 highs has seen price stalling just ahead of the 50% retracement from last year’s highs. If price corrects lower from here, the ledge of broken prior resistance around 106.90-107.50 in conjunction with a retest of the broken bearish trend line should provide support for renewed upside.
Indeed, positioning data further reflects the scope for increased upside in USDJPY as JPY longs remain intact despite some recent reductions.
The initial move in USDJPY is clearly well underway with USD having rallied around 8% against the Yen. However, in contrast to the magnitude of this move, USD has only rallied around 3% against the New Zealand Dollar suggesting that there is an opportunity to take advantage of further USD strength to come. In terms of explaining the Kiwi’s robust performance in the wake of the US election, the strongest candidate appears to be the link between NZD and equity markets which have strengthened considerably.
NZDUSD has now fallen below the rising bullish channel support which ash underpinned price action this year. The sell-off has also seen price breaking down below the neckline of a larger head and shoulders pattern creating good confluence should price retest this zone.
In terms of further catalysts this week, the key focus will be on the release of the November FOMC minutes. Whilst the meeting was held ahead of the election and so might have lost some relevance; traders will still be eager to gauge the minutes for any clues as to the likely pace of tightening. One of the key issues currently clouding the outlook is that of whether or not the Fed will allow inflation to overshoot.
Last week New York Fed’s Dudley reiterated previous comments that the 2% inflation target is “not a ceiling.” However, in contrast to these remarks, the more hawkish Kansas City Fed President George noted that the Fed should deliberately avoid overheating the economy. Traders will be keen to see whether the meeting minutes shed any light on this use.