USD Strength, EUR and GBP

DXY posts new high but global risk appetite still anchored for now The USD continues to go from strength to strength, though the question we need to ask ourselves now is whether the Fed story has run its course. After years of significant dislocation, markets are much closer to pricing in the Fed’s signalled path of future policy normalisation than they were prior to the US election; a Dec hike is all but a formality for markets, while Eurodollar futures are pricing in 42bp worth of higher US rates in 2017. We continue to think two Fed hikes will suffice for 2017 (even if inflation ticks up to 3%), meaning limited Fed-fuelled $ upside.

ECB rumours point to further stimulus in Dec; EUR to remain soft Reports surfaced yesterday that the ECB are looking into allowing eligible banks to borrow bonds held under the asset-purchase programme for use as collateral. While this may be seen as a step to tackle the ECB’s bond scarcity problem, our Rates Strategy Team note that it is more targeted at addressing market illiquidity issues. 1.05 in sight for EUR/USD amid ECB speculation and EZ political risks.

UK’s large twin deficits means GBP/USD may now trough out at 1.15 The Autumn Statement consisted of a series of small steps in the right direction, though we do not see these as having any game-changing implications for our bearish GBP outlook. The launch of a £23bn productivity investment fund, plans for a wide-range of infrastructure investment and the intention to lower corporate taxes to 17% are welcome policies to get the economy “match-fit” for Brexit, but the government will ultimately have to invest more if they want to stand a chance of winning. The OBR estimated potential growth in the UK to be 2.4ppts lower, in part due to lower trend productivity growth, while around half of the extra £122bn net borrowing by 2020-21 is a consequence of Brexit. We believe the UK’s large twin deficits (fiscal and current account) should not be underestimated as they will continue to exert downward pressure on GBP over the medium-term. Should the dollar remain strong, risks are that GBP/USD troughs out at 1.15 in 1H17.