US dollar still heading higher - Natixis

Research Team at Natixis, notes that the US dollar has extended its rise against most G10 currencies and emerging currencies, the DXY dollar index breaking out above 101.

Key Quotes

“This upward acceleration was spurred by heightened expectations the Federal Reserve will tighten monetary policy because of concerns inflation will be stronger during the Trump presidency.”

“Even though the programme of the president-elect is not yet known, the market expects a huge infrastructure spending programme along with cuts in income taxes and corporation taxes. If these measures are implemented, they can be expected to stimulate growth and lead to more intense inflationary pressures, notably on wages. Similarly, the market also expects US companies will be encouraged to repatriate profits earned abroad, one of the measures contained in the campaign manifesto that is likely to bolster episodically the US dollar.”

“Under these conditions, inflation expectations, as measured by the 5Y5Y inflation swap forward, have risen sharply, which has contributed to the sharp increase in US long interest rates. The probability of a hike in the Fed Funds rate, derived from Fed Funds futures, has soared to 96%. In her testimony before the Joint Economic Committee of the US Congress, Janet Yellen indicated that a tightening could well become appropriate relatively soon. On the other hand, the market prices in just one interest hike in 2017, not three as we expect, which leaves some upside potential. In this respect, we expect the US dollar to extend its uptrend, bearing in mind we see inflation rising to 2.6%, which will force the Federal Reserve to be more proactive than is being anticipated by the market.”

“Over the medium term, one cannot rule out some jolts being experienced by the US dollar, as a number of recent appointees hold radical views and could lash out at the strength of the US dollar, saying that it penalises US companies, while there will be the possibility the stimulus plan will not be on the grand scale expected currently. However for the US dollar, the underlying trend remains on the upside given that we expect a more aggressive interest rate hike than currently anticipated by the market.”

“This week, watch out for the latest appointments to the Trump transition team, for the next raft of macroeconomic indicators, notably durable goods orders, the PMI, and new home sales, and for the speeches by FOMC members.”