USD Rebounds, but Out of Favor at Start of 2018
- Weakness seen in the DXY Index at the start of 2018 is seen not only as follow-through from 2017, but investors pricing expectations for future policy endeavors.
- Divergence between US data and that from the rest of the world gives traders a reason to watch capital flows early on.
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We're onto day two of trading in 2018 and it seems like the US Dollar is still hungover from last year. Ongoing enthusiasm in US equities after the passage of the tax reform bill seems to have been lost on the greenback: rates markets have not changed the expected timing of the next rate hike (still due in March 2018); and the US yield curve (2s10s) remains near its flattest levels of the past year as long-term inflation and growth expectations haven't improved.
The simple reality is that the tax reform bill should be a boon for corporate earnings - which have been strong and continue to trend positive - but not necessarily for jobs growth. Ignoring the naive hopium of trickle down economics, the bulk of capital repatriated or earned via higher revenue (thanks to lower taxes) will be given back to shareholders via dividends or share buybacks; raises for workers (wage growth), hiring (jobs growth), or jobs training (productivity increases) are at the bottom of the priorities list for most US corporations (per this 2017 survey of corporations' intentions about the tax cut proceeds).
In a sense, now that US fiscal authorities are using their legislative ammunition to change the economy in ways that may not be beneficial for long-term growth, the US Dollar is a soldier without any bullets as it sets off into the fray of 2018. Asymmetric risk continues to proliferate for the US Dollar in the near-term, whereby positive economic data surprises will be more difficult to come by and disappointment is likely to result.
In other words, market participants won't be quick to pull rate hike expectations forward more than they are now without a gamechanger like an infrastructure spending bill in the immediate future - the tax bill, from the US Dollar's perspective, is a dud. Barring a change in the overall flow of economic data momentum and a change in tune from Congress and the White House, the US Dollar is out of favor with few reasons to be bullish at the start of 2018. Coupled with signs that growth is accelerating in Asia and Europe, capital flows to high growth potential regions may prove to undercut the greenback even further.
To this end, neither of the 'high' importance economic data releases scheduled for today - the December US ISM Manufacturing Composite and the December FOMC meeting minutes - should have a material impact on the mood surrounding the US Dollar. We're waiting for liquidity conditions to normalize, which doesn't seem likely before the December US Nonfarm Payrolls report this Friday.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
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