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US Dollar - 27th Feb, 2017

For the past two weeks investors have been scratching their heads over the underperformance of the U.S. dollar. Data has been good, the U.S. economy is improving and practically every Federal Reserve official who had an opportunity to speak said rate hikes are coming. So why has the U.S. dollar struggled to rally, particularly against the Japanese yen? The answer lies in expectations – the media has been talking up the possibility of a March rate hike and investors are just not convinced that it will happen so quickly. The Federal Reserve telegraphed plans to raise interest rates 3 times this year and many believe that these moves will be made at the quarterly meetings coinciding with Yellen’s press conference. The media has circled around these dates (the next one is in March) and rightfully so as the presser gives Yellen the opportunity to explain the central bank’s decision.

However Fed Fund futures show the market only pricing in a 36% chance of a Fed hike next month and a 63% chance of a move in May so there’s a misalignment between what the data is showing, what the Fed has been saying and what the market believes. We think the dollar should be trading higher but there’s no question that investors need more convincing. This could come in the form of an aggressive tax cut plan from Trump that provides the fiscal stimulus that everyone is waiting for, a hot non-farm payrolls report and/or clearer guidance from the Fed leadership.

While non-farm payrolls won’t be released this week, President Trump delivers a speech before a joint session of Congress on Tuesday where he is expected to unveil has “phenomenal tax cut plan,” which will be followed by speeches from Yellen and Fischer on Friday. In between we’ll hear from more U.S. policymakers, get a glimpse of the Beige Book and see how the U.S. economy has been performing. Manufacturing and non-manufacturing ISM reports are scheduled for release along with consumer confidence, personal income and personal spending. While these economic reports are important, Trump’s speech and policy plans will dictate how USD/JPY trades in the coming week. The currency came under heavy selling pressure in previous days and looks vulnerable to a deeper correction.

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