The US dollar and yields are falling, but Westpac doesn't think it'll last

Photo: Dean Treml/ Red Bull via Getty Images.

The US dollar rally continued to unwind on Thursday, with the US dollar index, or DXY, falling to the lowest level seen since December 8.

It has now fallen 2.4% from the 14-year peak of 103.82 struck on January 3.

As shown in the daily chart below, the decline in the DXY, shown in yellow, has followed a slide in US 10-year bond yields over the same period, continuing the pattern seen when both were moving higher following the US election held on November 8.

Source: Thomson Reuters

To Sean Callow, senior currency strategist at Westpac, the move in yields, and then followed by the DXY, has been driven by investor uncertainty as to whether Donald Trump will be able to deliver on his pre-election fiscal promises.

Here’s just some of the questions that he believes are yet to be answered, with no clarity provided by Donald Trump’s first official press conference as US president-elect held on Wednesday.

In particular, there is much interest in the size, mix and timing of any fiscal easing. Will the looser policy be mostly cuts to corporate and high income tax rates? Will infrastructure renewal be via direct government spending, as bond yields seem to imply, or reliant on tax breaks for the private sector as nominees have suggested. Is there likely to be a tax holiday on repatriated profits? What steps will be taken to slow imports from Mexico and China?

Callow says that investors were perhaps na├»ve to expect clarity at Trump’s press conference, widely cited as the catalyst behind the latest leg lower in the DXY.

However, while he admits that reflation hopes “took a small knock” this week, sending both US yields and dollar lower, he suggests that the underlying reflationary impulse is still very much intact.

“Expectations simply got ahead of the game,” he says.

Given that view, Callow says that the USD index will likely range between 100 to 104, although he says that “the medium term bias remains higher”.

Bolstering his confidence, he says that US dollar downside will ultimately be limited by Fed tightening expectations in the months ahead.

The DXY currently trades at 101.37.

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