USD looks solid in H1 2018, backdrop much more challenging in H2 – Westpac

According to Richard Franulovich, Research Analyst at Westpac, H1 2018 looks fertile for continuing USD upside as yield spreads should continue to broadly trend in the USD’s favour with tax cuts and still very accommodative financial conditions underwriting solid growth outcomes.

Key Quotes

“Real time estimates for Q4 GDP are tracking around 3%. If realised, that would make for three consecutive quarters of 3% annualised growth, a feat not achieved in the post-crisis era.”

“Fed speakers are unlikely to pre-commit Powell to an immediate March hike (his first as chair) but markets can still err toward pricing more Fed hike risk in H1 2018 (currently +25bp by June). Growth should continue to track near 3% thanks to solidly supportive financial conditions while the voting regional rotation schedule turns markedly more hawkish: 2017’s crop of strong dovish voters such as Kashkari and Evans are replaced by the hawkish Mester and centrist Williams.”

“The USD index can see another 4-5% upside from current levels, circa 94.0, putting it within striking distance of 100 in H1 2018.”

“Hard to see sustained USD upside much beyond mid-2018 though, as the macro picture is likely to be far more challenging for the USD thereafter.”

“Midterm election fever will be in full swing by mid-year, strong swings to Democrats in a raft of state and local races in 2017 raising the strong prospect that Congress swings back to Democratic control. All 435 House seats are up for reelection. Democrats need a 23 seat gain and on current polling could gain 30-40 seats. The Senate is tougher, 25 of the 33 Senate seats up for reelection in Nov 2018 already held by Democrats. A potentially Democrat-led House will look to claw back the Trump/GOP tax cut and deregulation initiatives. There’s no doubt their attempts to rollback Trump-o-nomics will be thwarted by presidential veto but uncertainty will still weigh on business and market sentiment.”

“The weight of evidence on US wages and inflation continues to build in favour of a structural shortfall. Disinflation via “Amazonification” continues to broaden and intensify. Amazon is not yet the dominant presence many make it out to be with revenues barely 1/3 of Walmart. The broadest and most reliable measure of labour market utilisation – the prime aged employment to population ratio – is still some distance from pre-crisis peaks and points to a continued benign wages outcomes deep into 2018. Given that, and with Fed funds in the vicinity of neutral by mid-year, there’s a non-negligible chance that the Fed adopts a more cautious tack in H2 2018.”