FX: The under-performing dollar

The rise in US rates at the short end of the curve has surprisingly delivered very little support to the dollar over recent weeks. For example, 2 year EUR:USD swap spreads are now at a staggering 225bp, wider even than in late 2005. True, spreads at the longer end of the curve are steadier, but the higher rates at the short end of the curve do make FX hedging exposure of US assets increasingly expensive.

Instead, it seems unhedged positions in global equity markets look a bigger driver of FX right now. USD/Asia, in particular, is starting to break lower as investors chase growth stories more globally. And with one Fed hike this year and two next year (March and September) virtually priced, it is questionable how much higher short-dated US rates can move right now, without an inflation break-out.

On the subject of the Fed, tonight sees the release of the minutes of the November 1st FOMC meeting, which looks unlikely to alter market expectations. Elsewhere, speculators price a 37% chance that a US corporate tax is enacted this year – much above the 17% priced in early November, but presumably held back by the prospect of dissent in the Senate.

Eurozone consumer confidence released later today should press 17-year highs and gently question whether the ECB is right to keep policy so loose. Last night the ECB’s Benoît Coeuré suggested the ECB, before September 2018, could potentially drop its link between on-going asset purchases and the need to see inflation on a path to 2%. We tend to favour EUR/USD drifting back to 1.1810/20 in quiet markets.

UK Chancellor Hammond will announce his budget today. The OBR is expected to revise GDP forecasts lower. Downward revisions to productivity (and expected government tax revenues) will limit Hammond’s room for giveaways. All this is known, however. Instead, we remain positive on GBP with reports emerging in the FT today that a divorce bill can be struck within three weeks. Cable to test 1.3320/40.

The National Bank of Hungar managed to meet the (high) expectations of the market yesterday by delivering an aggressive set of measures aimed at flattening the yield curve and encouraging residents to take a greater interest in fixed-rate mortgages. The yield curve is expected to flatten further. And the NBH’s experiment with QE (plan to buy mortgage bonds) has raised some eyebrows, although should not be enough to offset the support from Hungary’s 6% of GDP current account surplus. Expect EUR/HUF to remain flat into year-end.