USD: A Week For 2 Halves: What's Next & How To Trade It? - BofA Merrill

The week was a story of two halves for the USD. A good meeting between Presidents Trump and Abe, strong US data, including higher than expected inflation, and a somewhat hawkish tone by Yellen in her Congress testimony supported the DXY early in the week. Then, the index went back where it started, for no clear reason. The latter move may reflect fear of more verbal interventions against the strong USD from the Trump administration, disappointment why the USD did not strengthen even more early in the week, or simply few large flows (from corporates or central banks) that triggered broader USD selling. Risk assets continued to do well in the meantime, with US equities reaching new highs and EM FX appreciating further.

In Europe, markets are getting increasingly concerned about the French elections. French sovereign CDS spreads and yields spreads from Germany have reached their highest levels since the Eurozone crisis. The EUR/CHF risk reversal is approaching the level of the Brexit referendum. Although the polls suggest a very slim chance for Le Pen in the second round, investors are concerned following surprises in the UK referendum and the US elections last year and do not want to take a chance. Even if Le Pen loses in the second round, a better than expected result of PVV in the Netherlands on March 15, or a better than expected result for Le Pen in the first round could trigger market volatility. We are waiting for the details of the US fiscal plans to see a more sustained USD rally.

One of President Trump’s tweets this week suggested again that a tax reform plan was around the corner. We expect details about tax reform and other fiscal policies during President Trump’s address to the US Congress on February 28. We also note that the Fed is not assuming a fiscal stimulus at this point, which could in turn lead to faster tightening than what the Dot Plot includes now. We remain bullish on the USD. We expect US fiscal stimulus in H1.

Our favorite USD long trade* in the medium term remains against the JPY, as the BoJ’s yield targeting policy framework makes JPY the most sensitive G10 currency to rate differentials.

*This trade is recorded in eFXplus Orders.

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