Julius Baer Research | The combination of a positive economic growth narrative, like the fiscal boost under President-elect Trump, and good economic data, creates a powerful positive US consensus. Self-limiting forces of a stronger US dollar and higher interest rates are slowly emerging.
Sentiment has turned surprisingly fast in favour of an upbeat US economic outlook after Trump’s win of the Presidential elections. A number of good economic data are contributing to a positive US consensus. The underlying forces in this environment for a positively biased US view are quite powerful. The prospect of public spending and tax cuts under Trump is realistic. Despite the general absence of specific proposals in this regard, the Republican majority in both houses of Congress makes the fiscal boost narrative of a Trump presidency quite convincing. At the same time, key economic data surprised positively. Much better durable goods orders, more upbeat consumer sentiment and positive indications when it comes to this year’s Christmas shopping season, including Black Friday and Cyber Monday sales, have been reported in the last week. The rare combination of Trump’s fiscal boost and upbeat economic data creates a positive outlook.
The self-limiting forces in this environment should occur from a strengthening US dollar and from higher interest rates. Both contribute to a tightening of monetary conditions, which should correct optimism at some point. Nevertheless, this week is expected to deliver US data, which are suitable to feed the positively biased view further. The second reading for growth of US gross domestic product in Q3 is highly likely to result in an upward-revised rate. For November, the manufacturing Institute for Supply Management (ISM) reading is expected to signal accelerating growth ahead and robust non-farm payrolls on Friday will strengthen the case for rising Fed funds rates.
The dollar appreciation which started on the day after the US presidential election appears difficult, if not impossible, to stop. The economic narrative for a stronger US dollar is tied to the inflationary impact of the new president’s policy and, related to that, the now 100% probability of a rate hike at the Federal Open Market Committee (FOMC) meeting on 14 December. Additional rate hikes for 2017 are also expected by now, according to Fed funds futures pricing. Rising inflation in the coming months due to the base effect from higher oil prices will be a powerful support for this narrative in the coming months. We therefore adjust our 3-month US dollar outlook higher. Specifically, we forecast USD/JPY to rise to 117 and USD/CNY to rise to 7.10. We revise our EUR/USD fore-cast lower to 1.04 and USD/GBP to 1.22. Any negative growth feedback from higher interest rates and a stronger US dollar is currently overlooked and we expect this self-limiting effect to creep only slowly into the currency pricing going forward.
The inflationary impact of the new president’s policy proposals and higher interest rates are driving the US dollar higher while the negative feedback on US growth and equities is taking a backseat. We revise our 3-month US dollar forecasts higher.