All eyes on Trump’s initial policy plans for driving USD direction

USD: FX market trading in holding pattern waiting for Trump’s policy plans

The US dollar has continued to trade on a softer footing at the start of this week. It follows the first weekly decline last week for the dollar index since the last week of November. The weaker US dollar has been encouraged by reports of positive talks between President-elect Donald Trump and Chinese President Xi at the end of last  week. According to the Chinese readout of the call, President Xi said that he and Trump “attach great importance to mutual interactions” and “hope for a good start of the China-US relationship” during Trump’s second term. According to the report, Donald Trump “looks forward to meeting Xi at an early date”. At the same time, Chinese vice-president Han Zheng has held talks over the weekend with US vice president-elect J.D. Vance and Elon Musk at separate meetings in Washington ahead of Donald Trump’s inauguration today. The USD has lost upward momentum over the past week after recording strong gains over the last couple of months ahead of Trump’s second term. The latest CFTC report revealed another increase in long USD positions held by Leveraged Funds in the week ending the 14^th January, and they have now reached their highest level since all the way back in September 2018. It clearly highlights that long USD positions have become a very crowded trade leaving it vulnerable to a correction lower if market expectations for initial policy implementation under Trump disappoint.         

Similar price action has been evident in the US Treasury market as well in recent days. After hitting a high of 4.81% earlier last week, the 10-year US Treasury yield has since fallen by just over 20bps after the release of the monthly inflation data (CPI & PPI) for December provided a timely reminder that underlying inflation in the US continues to slow ahead of Trump’s second term. It raises the question of whether market participants have become too fearful recently over the risk of higher inflation in the coming years that has contributed towards the heavy global bond market sell-off. The Fed has already indicated that it plans to take some time at the start of this year to assess how the economic outlook evolves before cutting rates further. While further evidence of slowing US inflation is encouraging, the Fed will still be wary of upside risks to inflation from the implementation of Trump’s policies alongside the recent pick-up in employment growth. It will be difficult for the Fed to cut rates further if the labour market continues to improve at the start of this year. In light of these uncertainties, we remain more confident that other major centrals banks such as the BoE, ECB and PBoC will keep cutting rates compared to the Fed providing a tailwind for USD strength.   

In these circumstances, the week ahead is likely to prove pivotal for the performance of the USD and US yields in the near-term. Reports suggest 200 or more executive orders on Day 1. If the Trump’s initial policy plans fall short of market expectations for more front-loaded and broad-based tariff hikes, then the recent highs for the USD and US yields could turn out to be more significant peaks at the start of this year, and it would undermine our forecasts (click here) for further USD strength during the first half of this year. However, we still doubt how sustainable any setback for the USD will be with growth outside of the US set to remain weak and even more gradual and/or less broad-based tariffs should still ultimately be supportive for the USD.   

US YIELDS & USD LOSE UPWARD MOMENTUM AHEAD OF INAUGURATION

Source: Bloomberg, Macrobond & MUFG GMR

JPY: BoJ set to hikes rates again unless pick-up in financial market instability

The other main event in the week ahead will be the BoJ’s upcoming policy meeting at the end of this week. USD/JPY fell back towards support at the 155.00-level at the end of last week as market participants moved to more fully price in the probability of the BoJ hiking rates this week for the third time in the current tightening cycle. According to Bloomberg, the Japanese rate market is currently pricing in around 21bps of hikes for this week’s policy meeting.  

One factor that may have delayed a rate hike in December was the political uncertainty following the LDP losing its working majority in the Diet following the election in late October. But the political landscape is now more stable and the government have been clear recently that the decision to hike rests with the BoJ. Finance Minister Kato last week stated that the “specifics of monetary policy” should be left to the BoJ. Secondly, data last week will also encourage the BoJ to act. BoJ survey data released on Friday revealed an average inflation rate expected over the next five years of 9.2%, the highest in the data series going back to 2006. A record 45.8% of households expect prices to rise “significantly” over the next five years.

Finally, media newswire reports have become common ahead of BoJ rate hikes and the Nikkei reported at the end of last week that a majority of Monetary Policy Members will vote to hike this week. The only thing which could prevent the BoJ from hiking rates this week would be if there an unfavourable market reaction to Trump’s first days in office adding to the BoJ’s caution. With the market already more fully pricing in another hike now, we doubt that the yen will strengthen significantly especially as the updated guidance is likely to stick to gradual rate hike plans.  

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	10:00	Construction Output (MoM)	Nov	--	0.97%	!
EC	10:00	Eurogroup Meetings	--	--	--	!!
CA	11:00	BoC Business Outlook Survey	--	--	--	!!
CA	15:30	BoC Business Outlook Survey	--	--	--	!!
NZ	21:30	Performance of Services Index	--	--	49.5	!

Source: Bloomberg