Prospects of US tax cuts boost Dollar, worldwide stock markets

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13 February 2017

thomasdodds

Quiescent monetary policy in most Group of Ten countries mean that markets are for now focused on political developments.

L
ast week’s comments from Donald Trump promising “phenomenal news” on tax cuts in the US ignited a sharp rally in equities, emerging markets and risk assets in general. The US Dollar and Sterling were caught in a wave of optimism and rose against every G10 currency, save the Australian and Canadian Dollars. Special mention must go again to the Mexican Peso, which rose 1% against the US Dollar and nearly 2.5% against the Euro.

This week the global reflation story will undergo a major test, as we get a raft of inflation numbers. China and the UK on Tuesday are followed by the critical US number on Wednesday. A core inflation number above the universal consensus of 0.2% for the month and 2.1-2.2% for the year would probably be enough to push the Euro below its recent lows of 1.04 to the US Dollar. Any headlines on US tax cuts, the French and Dutch elections, and new concerns about the Greek debt could also shake the common currency.

Major currencies in detail

GBP

The UK economic calendar is heavy this week. In addition to inflation data on Tuesday we will also receive the latest labour report on Wednesday. We think there is a reasonably strong chance of an upside surprise in inflation, which may force markets to start bringing forward their expectations for Bank of England rate hikes and support of the Pound.

We expect the Pound to range trade against the US Dollar, although there is a good chance of a significant pick up against the Euro this week on the back of strong economic data out of the UK and rising political concerns in Europe.

EUR

Renewed concerns about the sustainability of the Greek bailout have been added to political concerns. French bond spreads have blown out, while Dutch sovereign debt remains quiescent. We think the market is overly worried about downside risks in France, where the two-round electoral system makes a Le Pen victory very unlikely. By contrast, the risks that Dutch nationalist enter the Government after the March elections are being underestimated in our view.

The likely dovish tone of the ECB minutes to be released on Thursday will amplify the effect of any upside surprises in US inflation on the EUR/USD cross.

USD

Last week brought some hope that the erratic Trump administration may back away from picking political fights and focus more on domestic economic policy. Trump reaffirmed US commitment to a “one China” policy, which insists Taiwan is part of the country, and had what looked like a positive meeting with Japanese Prime Minister Shinzo Abe. More importantly, the White House made noises about significant tax cuts, and promised to publish a detailed plan in the next few weeks.

In addition to the key US inflation number, there are several potential market moving events in the US next week. Fed Chair Yellen’s testimony to Congress on Tuesday will offer some insight on the pace of interest rate hikes Fed officials expect to implement this year.