USD: Initial Trump rally just pausing for breath heading into year-end - MUFG

The US dollar has remained on the defensive in the Asian trading as it continues to give back some of its strong gains in recent months notes Lee Hardman, Currency Analyst at MUFG.

Key Quotes

“Emerging market currencies and the yen which were hit hardest by Donald Trump’s election victory are outperforming. US yields have lost some upward momentum in the near-term as evident by the 10- year US Treasury bond yield failing to break above key resistance between 2.4% and 2.5% which is encouraging a partial reversal of recent US dollar strength. At the current juncture, we continue to believe that it is just a temporary correction with no fundamental justification for a sustained reversal of US dollar strength.”

“The last two remaining event risks heading into year-end are today’s ECB meeting and next week’s FOMC meeting. We are not expecting any significant policy surprises which should encourage a further decline in market volatility and paring of long US dollar positioning heading into year-end thereby creating favourable conditions for emerging market currencies to rebound further. However such favourable conditions are unlikely to persist beyond the near-term.”

“We believe that it will likely be too soon for the Fed to signal next week that it plans to raise rates more quickly in the coming years. The Fed will be cautious about updating their economic forecasts until they have greater clarity over the outlook for fiscal policy under President elect Donald Trump. As a result, we do not expect a material upward revision to the Fed’s dot plot forecasts at next week’s policy meeting. It is more likely to stick for now with their plans for two rate hikes next year and three in 2018.”

“The US interest rate market looks reasonably priced for the potential for two rates hikes next year which could be one reason that the move higher in US yields and the US dollar has lost some momentum in the near-term. However, we continue to see scope for US short rates to move higher next year providing more support for a stronger US dollar as the market still doubts that the Fed will be able to raise rates much further in 2018. We estimate that there are only three to four hikes discounted during 2017 and 2018 which appears too modest if fiscal policy is loosened significantly. In these circumstances, the US dollar is likely to remain a buy on dips in the near-term as the adjustment higher is not yet complete.”