Dollar resumes rally as hawkish Fed points to a December interest rate hike

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17 October 2016

Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.

Twin themes for last week were the resumption of the US Dollar rally against its major peers and, closer to home, some tentative signs of stabilisation in the British Pound after the tremendous punishment it has taken recently.

I
n the absence of major data, markets focused on the FOMC minutes that seemed to all but guarantee a December rate hike.

Sterling saw diminished selling pressure against the Euro as the bearish consensus reaches record levels, which is sometimes a sign that a counter trend move is in the cards, at least in the short term. GBP net short positioning now stands at a record low (Figure 1).

Figure 1: GBP Short Positioning (2011 – 2016)

In emerging markets the biggest moves were a sharp rally in the Mexican Peso, as Trump’s standing in the polls collapsed, and a deep sell-off in the Swedish Krona, knocked by shockingly weak inflation data.

We expect to see some fireworks this week as a series of critical data and monetary policy releases hit the wires. The main focus will be the ECB meeting on Thursday, where we expect President Draghi to dismiss any talk of a tapering in the QE programme as premature, which would weaken the Euro. UK inflation data out on Tuesday will provide the first indication of the impact of the Brexit vote on prices, following the Pound devaluation. The Bank of Canada policy meeting, Australian employment and an update on Portugal’s sovereign rating will round out a busy week.

Major currencies in detail:

GBP

Despite the continuing volatility, there were some hopeful signs of Sterling stabilisation against European currencies, though it joined them in the general sell-off against the US Dollar.

We now look to a data-rich week. On Tuesday, we will get September’s UK inflation data. We expect an above consensus print that will lead markets to start pricing out any further Bank of England cuts.

This, together with the extreme cheapness of the Pound and record levels of short bets against the British currency will make it difficult for Sterling to sell off much further.

EUR

There was little data out last week other than a lacklustre inflation production number, which we’ve grown accustomed to expect from the Eurozone economy.

This week the ECB meeting is far more important. We expect President Draghi to forcefully dismiss any talk of a tapering of asset purchases, which should weigh on the Euro.

Also notable is that the Eurozone periphery is coming back into focus. Rating’s agency DBRS will publish its updated sovereign rating on Portugal, with the chance of a downgrade to junk status that would bring about a loss of access to various ECB programmes. The Italian December referendum on constitutional changes comes into focus, as does the attempt to finally form a Government in Spain after a full year spent in limbo.

Overall, a pretty bearish mix for the common currency.

USD

Inflation numbers out on Tuesday and the third and last debate of the Presidential Election on Wednesday could provide further fuel to the US Dollar rally.

The debate should put the final nail in the coffin of the Trump candidacy, which at any rate looks to have fallen too far back in the polls to be salvageable at this point.

Inflation may well surprise to the upside, as we think economist expectations do not fully reflect the recent increase in energy prices.

Together, these events should clear the way for a Fed rate hike in November or December this year and 2-3 times a year thereafter, which is still far more than the markets are pricing in.

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