USD: Guided by the inflation speed limit - Nomura
|Analysts at Nomura suggests that the moves in financial markets since Donald Trump’s victory appear to be a straightforward story of US reflation which has meant higher US yields, stronger equities and a higher dollar.
Key Quotes
“But beneath this narrative lies something troubling: a significant portion of the rise in US yields can be attributed to higher inflation expectations. In the past, such rises in yields have been accompanied by smaller moves in the dollar. For example since 2000, when real yields rose along with inflation expectations, the dollar rallied by an average of 1%. Yet when real yields rose with falling inflation expectations, the dollar rallied by over 3%. This average is pulled higher by the dollar surge during the global financial crisis, but even excluding that episode, the average dollar gain has been 2%.”
“The other cause of concern is that comparing the current dollar move with previous periods in which real yields and breakeven inflation rose simultaneously, it appears too strong, especially when conditioning on the magnitude of the rise in real yields. Strong dollar moves are rare in this setting. The instances when that occurred were before 2008, when the USD had already fallen significantly and the Fed was switching from easing to hiking. We could draw a parallel with today, thanks to the prospect of fiscal expansion and the possibility of a more aggressive pace of adjustment in the policy rate in 2017, but the starting point of the dollar is not as attractive as those instances.”
“So for the dollar to continue to rally, we would really need to see inflation expectations fall with rising yields. Previous instances of such a combination have seen the dollar rally extended to 10% (excluding the financial crisis). The Fed’s ability to bring inflation expectations down will therefore be important in coming months. Worryingly, Fed Chair Yellen’s recent remarks concerning the uncertainty of the fiscal path going forward highlights the risk of the Fed falling behind the curve. Therefore, we think the next few months will set the stage for the dollar trend.”
Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. FXStreet does not in any way guarantee that this information is free from mistakes, errors, or material misstatements. It also does not guarantee that this information is of a timely nature. Investing in Open Markets involves a great deal of risk, including the loss of all or a portion of your investment, as well as emotional distress. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of FXStreet nor its advertisers.