US: Make the Dollar great again - Commerzbank

Ulrich Leuchtmann, Research Analyst at Commerzbank, suggests that Trumpflation (higher inflation expectations after the US presidential election) is encouraging the market to increasingly believe in a rate hiking cycle by the Fed which is lending support to the US dollar.

Key Quotes

“This development could become a self-reinforcing process. We expect more rapid USD appreciation.”

“Investors’ long-term US inflation expectations have been rising for quite a while now. But the outcome of the US presidential election has caused them to explode. The prospect of an expansionary fiscal policy, combined with protectionist measures, seems to be the perfect recipe for re-accelerating inflation. And therefore, the market is more inclined to believe in a Fed tightening cycle. As a consequence, the US dollar has risen sharply since the election. Will this trend continue?”

“The market’s rising inflation expectations were already reflected in survey-based inflation expectations before the election. If this process continues, there will be a good chance that US wage inflation may rise more strongly than it has done so far, providing the Fed with leeway for tightening which – as our Fed watchers believe – exceeds even the rate hikes that have already been priced in. So, if the process of rising inflation and Fed expectations is now getting underway, there will be a chance of the US currency rapidly appreciating. For the middle of 2017, we forecast EUR-USD exchange rates of around 1.03.” 

“But is EUR-USD parity now in sight? We would tread carefully here. It is becoming increasingly clear that the ECB cannot maintain its QE programme at current levels indefinitely – even with core inflation in the euro zone continuing to disappoint the central bankers. At their December meeting, policymakers will probably extend QE once again at current levels, but in the course of next year it could become clear that the ECB will be compelled to reduce the QE volume. Even if the ECB tries to substitute QE with other measures, it will not be able to avoid giving the impression that it is running out of expansionary instruments. This should support the euro and prevent a collapse of EUR-USD to extreme territory. We therefore leave our forecast for end2017 (1.04) unchanged.”