USD: Dancing on loonie tunes - Westpac

US dollar had several factors weighing on it this week as the boost to the USD from policy divergence is fading after the Bank of Canada’s rate hike this week showed that the Fed is no longer the only major central bank tightening policy, explains Martina Song, Research Analyst at Westpac.

Key Quotes

“Despite the well-flagged move, CAD was the strongest G10 currency on the week. While we don’t expect this to be the beginning of a sustained series of rate increases, it does weigh on interest rate differential advantages the US dollar enjoyed. Next week’s policy meeting may be too soon for the ECB to signal a change in QE just yet, but it’s a matter of time (we still think the 7 Sep meeting is a better opportunity, when staff projections are updated).”

“There was a cautious note too from Fed Chair Yellen at her semi-annual testimony to Congress. She sounded more dovish, and less certain that the factors weighing on inflation were temporary compared to the commentary in the Fed’s meeting minutes.”

“Meanwhile, US political difficulties have again flared up and also weigh on the USD. Donald Trump Jr’s emails were a sign that the investigation between the Trump administration and Russia are not going away soon. And while Senate Majority Leader McConnell delayed recess and promised a vote on the healthcare bill by the end of next week, the struggle to get enough support within the different factions of the Republican Party make pushing the pro-growth agenda unlikely. There are plans to have the debt ceiling voted on too before the August recess.”

“Multi-month though, we are more positive on the USD. The US should continue to increase rates gradually, and we continue to expect a further Fed hike in Sep and two more next year. Other central banks are not yet on the same path of rate increases. But the policy divergence trade, which had the Fed’s tightening cycle contrasting with easing elsewhere is mostly over. We see the greater part of the multi-year rally as complete.”