US budget deal positive for the US dollar

Democrat and Republican negotiators struck a budget deal on Tuesday night. The deal covers two years and is expected to be voted through the House on Thursday and through the Senate next week. The deal is an important positive sign that the past years political brinkmanship may be coming to an end.

For the Fed tapering decision the deal may add another argument for starting to taper already in December. Fiscal uncertainty has been one of the factors holding the Fed back – something that was proven justified with the fiscal debacle in October.

We therefore also continue to look for the Fed to start tapering at their meeting next week. Hence, in that respect the deal is USD positive. However, it does not necessarily mean that EUR/USD is heading significantly lower the next couple of days. Euro money market rates are moving higher and it is becoming increasingly expensive to swap US dollars for euros, which is also pushing the cross higher ahead of year-end. That said, when the stress eventually eases in the euro money market it is still our view that EUR/USD will head lower in 2014. In FX Top Trades 2014 we recommended to enter a bullish USD/CHF call spread as a short EUR/USD position in disguise.

This morning Swedish inflation expectations were published. They showed that Swedish 5y inflation expectations (mean) dropped from 1.9 % to 1.8 %. It might look as a small thing, but do not underestimate this trend. Although the median is still 2%, an increasing number of the 240 respondents are seeing long-term inflation falling below the 2% target. The situation is now starting to look a bit like in 1999. We believe that the Riksbank can not overlook this fact entirely. It is an indication of a gradual erosion of trust in Riksbank's ability or will to comply to the target. Hence, if anything today’s data support our view for a Riksbank rate cut next week. See graph on the next slide.