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 Tuesday 30 August 2016

PM Bulletin: What next for the dollar?

 

 

Janet Yellen’s Jackson Hole speech appeared to have something for everyone. Dr Yellen kicked off by stating that the case for a rate hike had strengthened in recent months. She said that the US economy continued to expand and was nearing maximum employment along with price stability. The dollar flew higher in the first few minutes after the text of the speech was published. However, it then fell sharply to hit the day’s low as traders and algos delved deeper into the contents of the speech. Traders tempered their expectations for a September rate hike as Dr Yellen went on to say that the economic outlook remains uncertain and faces disturbances and headwinds. However, she also said that she saw Fed Funds settling at around 3% in longer run – a level higher than predicted by analysts.

But once investors looked at the speech in more detail it was considered hawkish overall or at least more hawkish than expected. This was the view of currency traders who have pushed the dollar higher ever since. At the time of writing the Dollar Index is up around 1.7% from its Friday low while the USDJPY has rallied around 2.5% over the same period. Additionally, the major US stock indices ended lower on Friday in a move also consistent with investors factoring in a larger probability of a September rate hike. However, US equities bounced back sharply yesterday which makes one wonder what’s going on here. The prospect of higher interest rates isn’t good for equity markets generally, although a modest hike may help the banking sector. The dividend yield on the S&P 500 is around 2%. If investors could get a similar return from the bond market without having to take on stock market risk, then they would rush out of equities and into government debt. Of course it could be that equity traders still don’t believe that a September rate hike is on the cards, or they could be taking some comfort from Dr Yellen’s statement that Fed monetary policy was not on a pre-set course. In other words, we shouldn’t expect the Fed to raise rates every quarter as was predicted by the FOMC’s summary of economic projections back in December.

But could it be that it’s the US dollar which is giving us the clearest signal that a September hike is on the cards? There’s no doubt that the current rally in the greenback suggests a significant repricing is taking place. However, we can’t say with any confidence that this presages Fed tightening ahead of the US Presidential Election in November.  According to the CME’s FedWatch Tool, there’s currently a 24% probability that the Fed hikes in September (about the same as it was prior to the Brexit vote). This rises to 67% for December. Chart-wise, the situation looks hazy. The rally from Friday has certainly shaken things up a bit. But it’s still too early to say that the greenback has broken out of a downtrend when looking at the USDJPY, EURUSD or Dollar Index. Data-wise, we’ve just seen a strong reading for US Consumer Confidence in August. However, yesterday’s headline PCE reading showed inflation running at just 0.8% year-on-year while Core PCE (excluding food and energy) was a 1.6% annualised. By this measure the Fed could say that it has not yet reached its 2% inflation target. But investors will be paying far more attention to this Friday’s Non-Farm Payroll release. Another strong reading here will see the odds of a September hike slashed sharply.

David: But could it be that it’s the US dollar which is giving us the clearest signal that a September hike is on the cards?

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Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Tagged: Bulletin PM

Category: PM Bulletin


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