The Trump-inspired USD rally is about three weeks old and we have
already exceeded the highs from late 2015 and early 2016 on a
tradeweighted basis. Naturally, the question now becomes how much further can the USD appreciate and which G10 currencies should be most vulnerable.
To answer these questions is complicated, not the least given that the
considerable uncertainty that still hangs over the main driver of the
latest FX appreciation – the prospect for aggressive fiscal stimulus
from the Trump administration.
The fiscal policy outlook uncertainty notwithstanding, the scope for
further USD-strength will also depend on the prospects for further Fed
tightening. As it stands, the rates markets are still pricing c.40bp
less cumulative rate hikes by the end of 2018 compared to the FOMC’s dot
plot. Using historic correlations between USD TWI and the spread
between US 2Y rate and the G9 average rate would suggest that a
convergence of the market and Fed rate expectations could drive USD TWI
c.3% higher from here. Absent of any significant disappointments from
next week’s non-farm payrolls and ISM, further re-pricing of longer-term
Fed rate hike expectations could push USD higher still.
JPY and the antipodeans had to bear the brunt of the recent USD strength. The
main drivers of the USD/JPY remain the Nikkei and US yields.
Constructive Japanese data next week will remain good news for Japanese
stocks. This should help push the USD/JPY higher along with higher US
rates. There is some modest upside risk to the Australian economic data
with the main focus likely to be private-sector capital expenditure
data. While the data and iron ore prices could provide near-term support
for the AUD, rallies in AUD/USD will present opportunities to sell. We went short AUD/USD*
brought to its knees by a double whammy of resurgent USD and growing
political risks in the Eurozone. This may change a little in the coming
days with investors remaining cautious ahead of the Italian referendum
on 4 December.
other commodity currencies in part due to the recovery in oil prices
ahead of the OPEC on 30 November. The market has already priced in a
reasonable chance of a production cut so that the bar for a CAD-positive
surprise is high. Potential disappointment from Canadian GDP could
leave it vulnerable to a renewed bout of weakness against USD was well.
Last but not least, still sizeable market shorts continue to make GBP the
least vulnerable currency against USD. Potential disappointments from
next week’s UK data could put the GBP resilience to the test, however.