December Rate Hike Probabilities:
USD 80.2% = (Still in the cards)
EUR 2.5% – (Think December 2019)
GBP 81.9% – (Done deal, probably in November)
CAD 44.7% – (NAFTA uncertainty impact)
Fed Rhetoric 25bps
Excitement is sweeping the Street
As Congress seems set to complete
Reform that’s elusive
Which might be conducive
To helping the US compete
So how will this impact the buck?
I tell you it clearly won’t suck
It should free the Fed
To tighten ahead
For dollar shorts this is bad luck
Arguably the biggest news overnight has been that the US Senate has passed a budget resolution that may pave the way for the President’s mooted tax reform. While the procedures to get from here to enacting a law are still complex and there is no certainty they will be completed, this is certainly the best fiscal news we have heard in a while. Under the circumstances, it is not surprising that the dollar, as well as US equity futures, are higher this morning, nor that Treasuries yields have risen almost 5bps. If Congress is able to agree a deal and put it on the President’s desk, it is increasingly likely that the Fed will feel far more comfortable in following through with their current policy path. Remember, the Fed has penciled in not just a rate hike in December, but also three more next year. The market, while it has finally come around to believing in the December move, remains skeptical of further action in 2018, with barely half that amount priced for next year. As I have written consistently, at some point, there will be a convergence between market pricing and Fed rhetoric. I continue to believe the Fed is going to stay the course, which means the market is going to need to reprice their expectations. Higher US interest rates will continue to underpin the dollar going forward. Add to this the imminent announcement of a new Fed chair, who will almost certainly be more hawkish than Janet Yellen and it simply reinforces that view.
So looking at G10 currencies, the euro has fallen a quick 50 pips this morning, essentially unwinding yesterday’s gains completely. The news from Europe was not data driven but rather focused on the outcome of the EU summit meeting where UK PM May continues to try to move the Brexit talks forward while the rest of Europe wants her to commit to a payment before anything else gets done. Chancellor Merkel did sound upbeat on the prospects for movement by December, but I remain skeptical that anything of note will happen even then. Interestingly, the pound is not following the script this morning, trading slightly higher (+0.1%) after its Public Sector Accounts data showed surprising strength. Comments from BOE member Cunliffe seemed to cloud the issue, but net the market is taking it all in stride. Whether the BOE does hike rates in November or not, the one thing that is clear is it will be a single, isolated rate hike and not the beginning of a tightening cycle. The pound has further to fall.
The yen has actually underperformed significantly this morning, falling 0.7%, after new polls from Japan showed the most likely outcome of Sunday’s general election is that PM Abe will lose his two-thirds majority in the Diet. While he should still cruise to victory, it means that constitutional change will be exceedingly difficult and that even the ordinary act of governance will be somewhat impaired. Finally, in the commodity bloc, both AUD and NZD are under pressure, with the former feeling the weight of commodity price declines across both energy and metals, while the latter continues to suffer from the ongoing fallout of the elections bringing the Labour Party to power. In fact, Kiwi has fallen below 0.70 cents for the first time since late May. Adding it all up and I feel like the dollar is set to gain momentum as we head into the weekend.
In the Emerging markets, it can be no surprise that ZAR is the biggest decliner; falling 1.45% this morning after further political ructions roiled the market. Today’s slide stemmed from rumors that Deputy president Cyril Ramaphosa, a strong candidate to succeed President Zuma, and someone widely respected, is tipped to be fired. The ongoing internal strife within the ruling ANC party has been a millstone around the currencies neck and does not seem likely to end soon. It is hard to be bullish the rand. Away from ZAR, the CE4 currencies have all followed the euro lower this morning, and we have seen similar magnitude declines from both the MXN and BRL as the markets there wake up. While neither of the key LATAM currencies has made a new low here, both are trading near the bottom of their recent trading ranges and seem poised to break lower (dollar higher). Stay tuned.
Yesterday’s US data showed a remarkable plummet in Initial Claims, falling to 222K, its lowest level since 1969, and also saw Philly Fed print at a better than expected level of 27.9. So we continue to see a seemingly strong US labor market and strong manufacturing sector as well. In many ways it is remarkable that GDP growth in the US remains so desultory. Of course, counter to that good news was the Leading Indicators printing at -0.1%, potentially a harbinger of a future slowdown. This morning brings Existing Home Sales (exp 5.30M), which seem likely to disappoint slightly, as they have for five of the past six months. Despite what appears to be a fairly strong manufacturing sector, the housing market in the US has not been along for the ride.
Nonetheless, barring an outright collapse in the US data over the next six weeks, it seems to me the Fed remains on track to raise rates and that the short term correction in the dollar is ending.
Good luck and good weekend