USD: The Fed & President Trump’s policies are in focus – MUFG

Lee Hardman, Currency Analyst at MUFG, notes that the US dollar continues to lack direction against the other major currencies in the near-term and has stabilized at modestly higher levels following the US election and is now waiting for fresh direction.

Key Quotes

“One of the main developments overnight was more hawkish Fed rhetoric which is offering some support the US dollar. Dallas Fed President Kaplan who is a voting FOMC member this year stated that policymakers should raise interest rates “sooner rather than later”, and without paying excessive attention to market expectations. He would like to be “aware of what’s going on in the market, but I don’t want to over-read or overreact to it…market probabilities can change very rapidly”. He provided further evidence as well that the Fed is becoming more concerned about the risks of leaving rates too low for too long by stating that “we want to guard against a situation where we get behind the curve”.”

“The US interest rate has subsequently moved to price in a higher probability of the Fed raising rates as soon as in March. We estimate that the implied probability of a March rate hike is at just below 40%. The upcoming speech from Fed Chair Yellen on Friday will be watched even more closely to see if she provides another hawkish signal to prompt the market to price in an even higher probability of a March hike. If the Fed were to surprise the market and deliver their next rate hike in March it would encourage a further strengthening of the US dollar in the near-term. Even if the Fed does not raise rates in March, we believe that there is an increasing risk that it sends a hawkish signal that it plans to raise rates at their following meeting in May.”

“A return to more solid growth in the US and building upside risks to inflation are increasing pressure on the Fed to speed up the pace of rate hikes as the current loose monetary conditions no longer appear justified. The Fed still remains cautious over incorporating the potential full impact of President Trump’s policies on the outlook for the US economy. We still believe that plans for looser fiscal policy if delivered will pressure the Fed to speed up the pace of rate hikes in the coming years. However, the Fed is still waiting for more policy details from the Trump administration before updating their policy outlook.”

“In a speech yesterday, President Trump stated that his first budget will focus on public safety and national security. He is seeking to increase defence spending by USD54 billion which would be offset by savings elsewhere. He added that he will make a big statement on infrastructure spending when he addresses Congress today, and that he is going to be moving very quickly on regulatory reform. However, there appears some scope for disappointment on tax reform at least in terms of timing as President Trump stated that his tax plan will only be released once they have released their proposal on Obamacare and have a clearer indication of the costs involved. USD/JPY is likely to continue to drift lower in the near-term if President Trump fails to provide fresh impetus for reflation trades today.”