Markets expect dollar to be supported through both fiscal and monetary policy
As it turned out, yesterday’s US inflation numbers made no difference to the dollar’s run over the past two days. The Fed’s decision to hike rates by 25bps on Wednesday signposted a further three rate rises next year and means markets could be looking at a federal funds rate of 1.5% by next Christmas. The contrast between this and the ECB’s recent extension of loose monetary policy was the focus for the market yesterday: the yield premium on US over German debt reached the highest levels in over 16 years, helping press the euro to its weakest levels against the dollar in over a decade.
EUR/USD parity becoming a more realistic prospect
While the pace of the euro’s fall below 1.04 against the dollar has been sharp, calls for parity (a 1:1 exchange rate) are somewhat premature as the market enters its quietest period of the year. Nonetheless, a euro worth less than one dollar will be a realistic prospect in the first few months of 2017 as the contrasts between the two economies become more and more apparent.
Bank of England trim inflation expectations
In a similar fashion to yesterday’s US inflation figures, the Bank of England’s decision to hold rates yesterday was never going to rock the boat. The easing plans enacted in the wake of the referendum will still be trickling through to the real economy and economic conditions are yet to shift meaningfully (either positively or negatively) to justify the bank taking further action. This neutrality among the Bank’s policymakers will likely persist until after Article 50 has been triggered, whether that’s in March next year or beyond. The Bank took a somewhat negative view on inflationary pressures in 2017, trimming forecasts due to the modest recovery in the pound against the dollar and the euro over the past two months, prompting a spell of sterling weakness – most pronounced against its US counterpart.
Today, the calendar is light and so we expect volatility to be more muted. The dollar trimmed some of its sharp gains in the Asian session overnight, but this hasn’t stopped the Japanese yen from recording its sixth consecutive weekly decline. Elsewhere, Richmond Fed President Lacker will be speaking today and, while he’s a non-voter on the rate-setting committee, he’ll be watched for any insight on voting patterns and behaviours behind the dot plots that emerged two days ago. Lacker’s a known hawk and will likely continue to talk up the prospect of rate hikes at today’s speech.