marctomarket.com / by Marc Chandler / Nov 14, 2016
The euro has dropped almost six cents since the knee-jerk post-election bounce to $1.1300. The immediate driving force is the anticipated policy mix in the US. With the US economy already growing near the trend pace, and the Federal Reserve’s objectives of full employment and price stability (defined as 2% increase in the core PCE deflator), the central bank was already poised to lift rates.
The fiscal stimulus that Trump’s economic advisors have not backed away from is $1 trillion. Former Treasury Secretary Summers, a long-time advocate of deficit-financed infrastructure investment objects to the mix of the tax cut and new spending, but the magnitude is nevertheless breathtaking.
While most economists are focusing on either the higher US interest rates and a likelihood of a somewhat more aggressive Fed tightening cycle, or the possibility of a dramatically more stimulative fiscal stance. We see the combination (the policy mix) as an exceptionally potent force that will continue to propel the dollar higher.
Interest rate differentials provide an incentive structure for investors. Investors are paid to be long the dollar against most major currencies. This also means that for any given level of volatility, it is cheap to hedge European or Japanese exposure.