Fed has certainly helped the dollar’s cause - Westpac

The US dollar has recovered some lost ground this week against most G10 currencies, especially JPY and the commodity currencies, notes Sean Callow, Research Analyst at Westpac.

Key Quotes

“The Fed has certainly helped the dollar’s cause. In his Senate confirmation hearing, nominee for chair Jay Powell indicated that interest rates were heading higher and rebuffed the suggestion of tighter regulation on banks, sparking a steep rally in financial stocks.”

“In her testimony to Congress’s Joint Economic Committee, Chair Yellen declared that “In my view, the recent lower readings on inflation likely reflect transitory factors” and didn’t repeat last week’s qualifier that she is “very uncertain” about this. Yellen deemed economic expansion to be “increasingly broad based across sectors as well as across much of the global economy.” The US 10 year Treasury yield jumped on this text, boosting the US dollar against the likes of AUD and JPY.”

“Earlier in the week, Dallas Fed president Kaplan made a more forceful case for higher interest rates, and not just in “the near future” (pricing for a Dec rate hike has been above 90% for the past 3 weeks). He argued that “the size of the expected full employment overshoot is growing” and that this should be a factor in assessing policy i.e. the further the unemployment rate falls, the less the FOMC should be worried about inflation undershoot.”

“It is not clear whether this view has much traction at the FOMC but Kaplan also has concerns about financial imbalances. He cited high corporate debt, low equity price volatility, thin volumes and of course, historically stretched valuations. As the chart shows, the rise in the price/earnings ratio of the S&P 500 has been driven mostly by higher prices, not earnings.”

“If the Senate tax package passes, US equity sentiment should find further support from its skew towards permanent corporate tax cuts. If the Fed judges that this will also boost growth (not so clear), it should reinforce the yield support for the dollar into 2018.”