The dollar strength is an increasing factor in markets as Treasury yields shoot higher. The reaction to Donald Trump’s tax plan and the potential for a hawkish Kevin Warsh taking the chair of the FOMC is helping to underpin the dollar. Inflation and earnings growth are still key factors, with the Non-farm Payrolls report in focus. We take a look at the outlook for forex, indices and commodities markets as the final quarter of the year begins.
Janet Yellen is sticking to the theme from the FOMC, despite subdued inflation the Fed is comfortable with raising rates. The FOMC dots say one more hike in 2017 (likely December) and three more next year. However, traders are questioning the Fed’s ability to achieve this with inflation so subdued. The yield curve flattened in the wake of the Fed. So the driver of a sustainably stronger dollar is unlikely to be the Fed. Higher inflation and growth will not be driven by tightening monetary policy, the US needs fiscal stimulus to dive yields higher. Cue Donald Trump’s tax plan. In the last week the 2s/10s spread rose sharply to a one month high on the back of Trump’s proposed tax reform plan. The initial plan looks to be fiscally positive and a likely driver of inflation. So if successful, the market is looking to Trump’s Tax reform to drive sustainably higher inflation and subsequently sustainably higher yields. If the Republicans can get it through Congress, tax reform would be a crucial driver of financial markets in the coming months. However, therein lies the problem. Trump’s healthcare plan was meant to have been the easy part of legislation this year and that has failed. The Democrats will not accept low and middle income Americans losing out whilst wealthy individuals and corporations benefit. The repatriation of corporate foreign profits would also be key, but if the Republicans cannot get it through Congress, then there will be a lot of disappointed dollar bulls.