Party time for US as dollar and Dow Jones reach new highs

It’s a bad day for turkeys, but not for USD traders. The dollar index surged to its highest level since 2003 yesterday, and greenback strength is particularly noticeable versus the Japanese yen, which has lost more than 1% versus the USD in the last 24 hours. Considering USD/JPY is considered a key gauge of market sentiment, the market for US assets is hot right now, and the Dow Jones also reached a fresh record high on Wednesday.

While we expect things to quieten down over the next two days for the Thanksgiving holiday in the US, the strong USD/ rising US yield theme is likely to persist through to the end of the year. 10-year US Treasury yields are at their highest level since 2015, and since Donald Trump won the US Presidential election, yields have risen by some 65 basis points.

A December Fed rate hike is one way bet

A key driver of USD strength is expectations that the Fed will raise interest rates next month.  The November minutes, released on Wednesday, gave a clear signal that rates will rise when the Fed meets next month. Some members noted in the minutes that “to preserve credibility” a 25bp rate rise needed to occur “at the next meeting.” This is about as explicit as you will get from the Fed.

Fed Fund Futures are pricing in a 100% chance of a 25bp hike next month. While we expect the Fed to hike, the market is so once way right now, there is an attractive risk/reward betting on them not hiking in December, the Fed have surprised markets before, although not to this extent. Interestingly, the market is also pricing in a 30% chance that rates could rise three times in the next 12 months. Considering the Fed has only hiked rates once since 2006, this is a pretty aggressive pace of tightening that the market is expecting, which is also dollar positive.

Government borrowing, the next big thing for FX

The prospect of fiscal largesse under a Donald Trump Presidency, and a multi billion stimulus plan, potentially as early as next year, is a key driver of the stronger dollar right now, as it could free up the Fed to hike interest rates in 2017 at a faster pace than most in the market (60%) think is likely. Thus, watch this space for Treasury yields, if the Fed is willing to trade monetary stimulus for fiscal stimulus then Treasury yields could have much further to go on the upside, and the financial market reaction could be sharp and severe.

The Autumn statement to end all Autumn statements

This is quite literally true, the most headline grabbing feature from Wednesday’s Autumn statement was that there will be no more Autumn statements, instead Philip Hammond will be a once a year kind of guy when it comes to the Budget. And no wonder he only wants to deliver the Budget once a year, the Chancellor told us on Wednesday that the UK’s debt load will surge to an eye wateringly high 90% of GDP next year before falling slowing over the following years.

Borrowing is back in fashion in the UK

The new Chancellor has no plans to balance the UK’s books during this parliament. This is a massive step change for the UK government, under George Osborne fiscal consolidation was the cornerstone of his strategy for the UK economy. The pound had a delayed reaction to the Chancellor’s a

statement, but once it got the memo that in the current economic environment debt appears to be good for FX, then the pound managed to buck the G10 sell off and actually eke out a gain versus the USD. It will be interesting to see if it can have another stab at 1.25 in thin trading on Thursday. Personally, I prefer short EUR/GBP, if fiscal stimulus and rising debt levels are driving the FX world, then Europe’s austerity plans could weaken the euro in the long term. The next target for EUR/GBP on the downside is   0.8255 – the 200-day sma.