It may not be long before we see more significant profit taking in equities and currencies. The signs are there – stocks hover near record highs but are struggling to extend their gains. Equities consolidated for the fifth straight day but currencies and Treasury yields are beginning to sell-off. In fact the beginning of the week decline in the euro and Japanese Yen crosses could foreshadow a deeper pullback in stocks. We’re not looking for a 5% correction, but with the Dow Jones Industrial Average hitting a record high almost every day this week since November, a pullback is long overdue.  

President-elect Joe Biden is expected to share his long awaited stimulus plan on Thursday and it could be trillions of dollars. There’s no doubt that it will include funds to speed up vaccine distribution, funding for unemployment insurance will increase, larger direct payments, extension to eviction moratorium and more government aid. The bigger the stimulus package, the stronger FX risk rally. However another sizable check for households may not be easy to pass so an initial rally could also fade quickly. If Biden opts for a smaller package that is easier to pass, stocks could sell-off in disappointment. Currencies take their cue from equities, so a sell-off in stocks will drive yen and swiss crosses lower

Concerns about violence on inauguration day and worries about President-elect Biden’s new policies would also be reasons for profit taking in equities but both effects will be short-lived. Senator Mitch McConnell said he will not bring the Senate back early, which means if the President were to be impeached, it would be after he leaves office so at minimum that uncertainty won’t be an issue for stocks.

Consumer prices in the US rose 0.4% in the month of December. The monthly increase was in line with expectations but the year over year rate was slightly higher at 1.4%. Rising inflation is one the main concerns this year and fueled quite a bit of speculation about earlier Fed tapering. As we noted in yesterday’s piece, it is far too early to talk about tapering but this is one of the main reasons why the dollar is trading higher against all of the of the major currencies. 

EUR/USD spent its third straight day below the 20-day SMA. If it breaks below 1.2130, we could see a swift decline to the December 9th low of 1.2060. Aside from stricter restrictions in Germany and the government’s warning that lockdown restrictions could remain in place for another 8 to 10 weeks ECB President Lagarde said they are monitoring exchange rate movements very closely. ECB member Villeroy was more specific, saying they are watching the negative effects. With restrictions expected to remain throughout January and February in the Eurozone’s biggest economy, it is hard to see EUR/USD hovering near 2.5 year highs for much longer. We continue to look for a near term correction that should take the pair to 1.20.

The Australian and New Zealand dollars extended their losses as China slammed Australia for politicizing an M&A deal on national security grounds. New coronavirus cases in China also hit a 5 month high, raising concerns that the virus is resurfacing in the region. The Canadian dollar saw modest losses thanks in part to stronger inflation data. 

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