US: Greenback comeback - Westpac

Sean Callow, Research Analyst at Westpac, explains that the US Dollar Index is on track for a third straight weekly rise, with a strong case for a fourth such week ahead.

Key Quotes

“Yield support looks to be key. For a few sessions after the 10 year Treasury yield jumped on the FOMC headlines, investors faded the move, the yield slipping back under 2.22% early this week, versus 2.23% pre-FOMC. At time of writing however, it is 2.34%, a high since 14 July.”

“Yield support is also clear at the short end, with Bloomberg calculating a Dec17 rate hike as 70% priced in, compared to a low of 22% just 3 weeks earlier. How much further yields can rise near term we shall see, with one potential obstacle Friday’s August update on the Fed’s preferred inflation measure, the core PCE deflator. This was just 1.4% y/y in July, a low since Dec 2015.”

“But news flow is supporting the yield move. The collapse of the Republicans’ latest healthcare proposal was not lamented among investors keen for a return to tax reform, given that “reform” tends to mean mostly corporate tax cuts. The headline proposals such as a 20% corporate tax rate and substantial personal income tax cuts will be very expensive for the budget bottom line.”

“The decline in the US corporate tax burden since the 1980s has not boosted business investment, so there is reason to be skeptical of some of the claims of the economic benefits or the plan. What is eventually passed could be considerably more modest. And a deal on infrastructure seems even more distant.”

“But near term, with the government funded until Dec and the debt ceiling next year’s task, US policymakers can focus on tax cuts. Wider deficits and (maybe) faster growth would be a bullish mix for the US dollar. This also dovetails into the euro’s softness in the wake of the German election, where Chancellor Merkel’s CDU lost votes to the far right.”