USD bull market regains upward momentum - MUFG

Lee Hardman, Currency Analyst at MUFG, notes that the US dollar rally has accelerated in the Asian trading session after the dollar index clearly broke above key resistance yesterday from the previous cyclical high at around 101.5 recorded in December of last year.

Key Quotes

“It brings an end to the period of consolidation which has been in place since March of last year. We would not be surprised to see at least another 5 to 10% upside for the US dollar heading into the middle of next year as the bull market has embarked on the another leg higher. In the first and second stages of the US dollar’s advance, the dollar index increased by around 14% between September 2011 and July 2012, and by around 25% between July 2014 and March 2015. One potential constraint which could help to dampen further upside is that the US dollar is already very overvalued according to our longterm valuation model estimates.”

“The election of President Trump has re-energised the US dollar bull market. It has more created scope for the market to price in expectations for a further widening of monetary policy divergence between the Fed and other major central banks supporting a stronger US dollar. A significant loosening of US fiscal policy will increase pressure on the Fed to speed up the pace of rate hikes in the coming years. Even without upcoming fiscal stimulus, the case for further monetary tightening had already strengthened as the US economy has returned to more solid growth in the second half of this year and domestic inflation pressures continue to build. Economic growth in Q3 is likely to be revised higher to above 3.0% and the Atlanta Fed’s current run rate estimate for growth in Q4 has increased to 3.6%.”

“The improving growth and inflation outlook was acknowledged yesterday by Fed Chair Yellen in her testimony to Congress when she signalled that a rate hike could be appropriate “relatively soon”. A resumption of rate hikes in December appears almost a done deal unless there is a negative shock. At the current juncture Fed Chair Yellen was unwilling to speculate how the Fed’s outlook for policy would change under President Trump. She was only prepared to go as far as saying that when there is greater clarity about future economic policies, the FOMC will have to take them into account and adjust their outlook. However, she did acknowledge that the markets see “inflationary consequences” from fiscal expansion and advised that the government should take into account that the economy is close to full employment when setting fiscal policy. She was also questioned about her future as Fed Chair and stated that she intends to see out her term until February 2018.”