Aside from the incredible bull run higher seen on Wall Street, the key story for early 2018 has become the sharp weakness on the US dollar. This is impacting across financial markets as the Dollar Index has fallen to levels not seen since January 2015. But what is driving the move and what is the outlook on forex, equities and commodities markets? We take a fundamental and technical look under the bonnet.
There have been signs over the past week of a subtle shift away from the ultra-loose monetary policy paradigm. The Fed has been tightening policy for 2 years but the ECB & Bank of Japan could follow suit this year. December was the first month on month decline in BoJ total assets since the massive QQE program began in late 2012, whilst it has also cut monthly asset purchases of longer dated JGBs. There is speculation that a “stealth tightening” is underway. The big signal would be the 10 year JGB yield moving above 0.10% which has limited market fluctuations since the BoJ introduced a zero yield target. Allowing the 10 year to rise to maybe +0.25% would be a big shift. Yen futures positioning reveals a market deeply short, meaning room for a significant short covering rally. December meeting accounts show the ECB moving towards ending its asset purchase program as it could revise forward guidance in early 2018. Looking to gradually adjust its language to reflect improving economic prospects “without a change in sequencing”, would likely mean adjusting QE guidance first. This could remove the potential to increase “in size and/or duration” or the possibility to extend beyond September 2018 in the meetings ahead. This has driven German Bund yields higher and negatively impacting on the dollar. The dollar no longer has first mover advantage and if inflation fails to significantly ignite, the outlook seems to be tough for the coming months.
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