Jane Foley, Senior FX Strategist at Rabobank, notes that over the past month the USD has lost ground against all of its G10 peers with the exception of the JPY and the failure of the greenback to rally in response to the passage of the Republican tax bill last month is a function of several factors.

Key Quotes

“These include scepticism about the degree to which the reform will raise US economic growth, the extent to which the news it has been already been priced in and also the shift in market focus away from the tightening cycle of the Fed to other central banks in the G10.” 

“Relative to its peers, the US economic recovery is well established.  The Fed started to reduce policy accommodation back in 2015 and the strong appreciation of the USD from mid-2014 into early 2015 was triggered by anticipation of the Fed’s move.  Although USD bulls briefly found a second wind on the back of Trump’s success in the 2016 US Presidential election, the DXY dollar index is currently trading over 10% below the high struck almost exactly 1 year ago. Disappointment about the slow pace of Trump’s legislative successes and a reworking of expectations about the build-up of inflationary pressures in the US can be linked with the soggy USD.  Another factor weighing on the DXY over the past year was the turnaround in the fortunes of the EUR and a re-balancing in favour of the single currency.”  

“Last year the EUR’s strong performance was triggered by better growth in the Eurozone and a more stable political backdrop than had been expected.  This year, the outlook for the EUR is likely to be dominated by the debate regarding the reduction in liquidity from the ECB.  Talk of less accommodative monetary policy settings has also emerged in Japan.  The threat of further rate hikes is being discussed in reference to central banks such as the BoC and the BoE, while the Riksbank, RBA and RBNZ may also tighten policy in 2018.  In essence the Fed is no longer the only major central bank on a tightening cycle and this will likely sap the ability of the USD to benefit from carry trades in 2018 vs. other G10 currencies.”

“There is no real expectation that either the ECB or the BoJ will hike rates in 2018.  However, the ECB has already tapered its QE programme and may end it after September, possibly with a view to hiking rates in 2019.  Eurozone economic data released over the coming 6 to 8 months will determine the extent to which the market prices in a tightening of liquidity in the Eurozone.  This will be crucial in guiding the value of the EUR in 2018.  Assuming the continuation of strong Eurozone economic data, we have revised up our 6 mth EUR/USD forecast from 1.20 to 1.22.”

“In Japan, whether or not the term of BoJ Governor Kuroda is extended after April could impact market expectations about the likelihood of a shake-up of the BoJ’s QQE programme in the foreseeable future.  Even if dove Kuroda remains at the helm of the BoJ, talk of the BoJ backing away from QQE may still persist.  Kuroda’s mention of the term “reversal rate” in a speech in November has heightened the debate about whether or not low yields are curtailing the will of banks to lend.  For now, Japan’s very low CPI inflation rate should keep the BoJ’s QQE programme on course.  However, Japan’s severe labour shortage combined with higher oil prices could stimulate some inflation.”  

“Although any change in the tone of BoJ policy could send the JPY higher this year, this could be a costly trade if the BoJ continues on its current policy course.  In the near-term, we would be reluctant to extend JPY longs significantly, though we will be watching the BoJ closely this year.  Our 6 mth USD/JPY forecast of 113.0 is based on the assumption of no significant policy change at the BoJ this year.  Any change in tone at the Bank could push USD/JPY below 110.”

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