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US Dollar, US 2Y Yield at New Highs as Trump Reflation Trade Rolls

US Dollar, US 2Y Yield at New Highs as Trump Reflation Trade Rolls

Christopher Vecchio, CFA, Senior Strategist

Talking Points:

- Trump reflation trade identified last week rolls on as markets digest prospects of fiscal stimulus, pivot in US trade policy.

- Pressure refuses to abate from commodity currencies, EM FX amid rising US yields.

- See our preview for the top data due out over the coming week.

The US Dollar (via DXY Index) is trading at an 11-month high, while the US 2-year Treasury note yield has hit its highest level since January. Both are more evidence of the regime change in market expectations for various items, including: Washington gridlock; US fiscal policy; the necessity for Fed rate hikes; and the prospect of a Euro-Zone break-up.

For the first, US-centric batch of items, it's important to throw away political dogma when considering President-elect Trump; while a Republican in name, his proposed fiscal policies don't sound like they're coming from depths of conservativism. As we pointed out last week, President-elect Trump's unorthodox rise in context of the Republican's wave election means that a) gridlock in Washingon will probably come to an end and b) as has historically been the case, when one party controls both Congress and the White House, the US structural budget deficit has increased by +0.4% per year. In effect, rising US yields, stronger US equities, and a firmer US Dollar all point to rising inflation expectations, which should cater to a more hawkish Fed down the road.

The last point - the prospect of a Euro-Zone break-up - is a new arrival as a reaction to the US Presidential elections, but given the European electoral calendar over the next year, it's very relevant. The populist storm that birthed Brexit and President-elect Trump isn't finished; it's pivoting to hit the European continent repeatedly over the next 18-months.

On December 4, the Italian constitutional reform referendum will provide the country with an opportunity to force a general election if the vote fails. Italian Prime Minister Matteo Renzi has said that if his proposals to limit the Senate’s legislative powers are rejected, he will consider resignation, opening the way for a general election in early-2018. There is a real possibility that Renzi’s Democratic Party could suffer defeat to the anti-EU Five Star Movement, with Beppo Grille starring as Donald Trump. This anti-establishment party has already said that, if elected it would hold a referendum on whether Italy stays in the EU.

The first half of December will prove volatile for EUR/USD, with the Italian constitutional referendum (December 4), the Austrian Presidential elections (December 4), the UK Supreme Court Brexit hearings (December 5-8), the European Central Bank's policy meeting (December 8), and the Federal Reserve's policy meeting (December 14).

See the above video for a technical review of the DXY Index, EUR/USD, GBP/USD, AUD/USD, USD/JPY, USD/CAD, and Crude Oil.

Read more: EUR/USD Biased Lower with Fed Hike, ECB QE Extension Eyed in December

--- Written by Christopher Vecchio, Currency Strategist

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