Over the last three weeks, the USD has gained more than 6% versus the Japanese Yen, nearly 4% against the Euro and USD Index has reached its highest level in over 13 years at 102.10. Further, the US SP 500 and Dow Jones 30 both pushed into new record territory. But the strong surge in the Greenback and US Stocks met resistance last Friday with the G-7 pairs closing well away from the best levels on the session. This pullback has FX strategists wondering if the US equity run is over and it’s time to sell the US Dollar.
Statistically, there is no question that the US Dollar has gotten ahead of reality and a correction of some degree is reasonable. However, it’s important to recognize that the sharp rally in the USD and US Stocks, along with surge in US Bond yields has been driven by 3 fundamental factors: position adjustments to USD and US rates, the prospects of an aggressive fiscal program from the new US administration and the expected impact of higher US inflation.
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Along this line of thinking, the US FED FUNDS futures have fully priced in an adjustment higher in the FED Funds target next month to .75% and nearly a 40% chance of another 25 basis point hike by May of 2017. With the second rate hike not expected until the middle of next year, the USD and US Stocks could take another leg higher if the FOMC statement suggests that further rate normalization could come sooner.
This means that the USD correction could be swift and unbalanced across the G-7 pairs. For example, a large percentage of the USD/JPY rally has been driven by US yield spreads gaining against Japanese Government bonds. This is not the case for the sell off in the AUD and the EURO. The Euro faces a list of political and economic troubles which should keep the pair under pressure going into the end of the year. Which brings us to the Sterling; which has firmed against the USD over the last few sessions.
The GBP/USD looks to be setting up for a breakout after consolidating over the last week. The big story driving the Sterling last week was UK Chancellor Hammond’s comments about the budget. While Mr Hammond lowered his growth forecasts for the next two years, he promised more borrowing and investment into innovation and infrastructure. He also announced a new National Productivity Investment fund of £23 billion and plans to double UK export finance to make it easier for British businesses to export.
These new spending plans were not expected which pushed the EUR/GBP sharply lower and lifted the FTSE 100 to its highest close in two weeks. With respect to Brexit politics, Prime Minister May repeated her plans to trigger article 50 by march of 2017 and exit the European Union by March of 2019. As such, we believe that the Sterling will outperform the Euro, USD and the other G-7 currencies over the near-term as the USD and US Stocks correct lower.
