The US dollar ends the year with a decline. Despite the fact that the Fed is pursuing the most aggressive policies among all major central banks, investors are slow to buy the dollar. To put it in another way, the prerequisites for reorienting financial flows have not yet been created.
If you focus on the CME futures market, the forecast on the rate still looks convincing, while the probability of the next increase in March is more than 50%. This seems to be optimistic, given the weak inflation indices and the market may not have taken well the words of Janet Yellen, spoken at the last press conference this year.
According to Yellen, the period of low inflation may extend for a longer period than previously thought, and its causes are deeper than it is commonly believed.
Fed Representatives in their public statements repeatedly referred to the so-called dependence of Phillips, according to which the inflation will necessarily begin to grow if the labor market grows. This is logical, as the reduction in unemployment means the growth of jobs, the demand for labor, the growth of wages, which indicates consumer activity. However, something went wrong in practice. The reduction in unemployment to multi-year lows has not led to either an outpacing increase in wages or an improvement in the structure of the labor market.
The ratio of the number of jobs and the number of people dropping out of the workforce has positively improved somewhat in the recent years. The ratio for November is 1.54 and roughly corresponds to September 2010. At present, the pre-crisis levels are completely inaccessible. In other words, low unemployment is a fiction created by an "improvement" in the counting methodology and not by a real growth in the economy.
The same conclusion follows from a change in the level of savings. In November, the savings volume of citizens fell to 426.2 billion dollars. This is the minimum level since August 2008 which clearly means a lack of income. How can inflation grow in these conditions?
Thus, Trump's signature on the tax reform law will have a crucial role for the United States. Reform should contribute to real improvement in the labor market, rather than formal. It should also increase the real incomes of the population and help increase consumer activity. In the corporate sector, the most important expectations are related not even to the reduction of taxes but to the repatriation of capital. The growth of the US economy, the growth of the stock market and three-time increases of the rate in 2017 did not contribute to increase the demand for the dollar. This situation needs to be changed, and therefore the possible return of several trillion dollars is exactly the necessary element of the entire reform, for which everything was started. Without the capital inflow, the Trump administration simply will not have the money either for reforms, for new infrastructure projects, or for fulfilling campaign promises.
The dollar exchange rate will directly depend on how the large business tax plan will be perceived. If the terms of this plan are accepted, and capital begins to return to the US, the dollar will resume growth from January.
Until the end of the week, it is expected that there were no market drivers capable of changing the alignment of forces in the foreign exchange market. The first week of the year promises to be more interesting. The ISM business activity report for December will be published on Wednesday, January 3. At the same time, the minutes of the FOMC meeting on December 13 will be issued that evening. Since the meeting was held as a whole in accordance with the expectations, the protocol will most likely do not have anything new, but it may contain information about whether there were others who disagreed with the rate increase, except for Evans and Kashkari. If so, the dollar is likely to react to the publication of the protocol by the fall.
* The presented market analysis is informative and does not constitute a guide to the transaction.
