USD: Too far too fast? - Rabobank

Jane Foley, Senior FX Strategist at Rabobank, suggests that the post-election rally in the USD is showing signs of running out of steam as the upward pressure on yields relents. 

Key Quotes

“The market has spent a great deal of last year and this year moderating expectations regarding the pace of Fed tightening.   While inflation expectations had begun to tick higher in October, the current awakening is mostly the result of assumptions regarding much looser fiscal policy in a Trump Presidency.  Speculation of more spending on US infrastructure, defence combined with generous tax cuts certainly have the potential to unleash inflation.”

“However, there are several caveats to these expectations.  First higher yields will make government borrowing more costly.  This alone has the capacity to rein in any Trump spending splurge.”

“There are presently so many unknowns with respect to US fiscal policy projections that it is very difficult to draw strong conclusions about a Trump presidency will change the landscape for the Fed.  That said, as a rule central banks dislike volatility and in this context it is possible that Fed Chair Yellen may use her testimony later this week to calm the market.  EUR/USD has this week failed to hold below the January low around 1.0711 and we would expect this to offer strong support in the coming sessions.”  

“Our expectation that the USD could soften on a 12 mth view towards EUR/USD1.14 is drawn from the assumption that US protectionist policies could slow growth, not least through a rise in cost push inflation. Once again, however, it is difficult to draw firm conclusions at this stage about the changes that Trump could make.  At the same time, next year could unleash a period of political tension for the Eurozone, starting with the Italian referendum next months and into the Dutch and French elections in the spring.  At the very least, these are likely to create volatility for the EUR crosses, but the Eurozone’s current account surplus and the safe haven appeal of Bunds should offer downside protection.”