Little was stirring in currency markets on Friday as dealers bedded down for the Christmas holidays, though the mood remains bullish for more dollar gains in the New Year as yield spreads widen in its favour. With Tokyo already absent, the dollar was dozing at 117.50 yen after reaching 118.66 yen a week ago, its strongest since early February. It was also almost back to where it started the year having been as low as 99.00 in June.
The single currency was a shade firmer at $1.0440, having rebounded only modestly from a nearly 14-year low of $1.0350 set earlier in the week. The dollar index was marginally lower at 103.04 and within striking distance of the week's 103.65 peak. So far on Friday, the index had moved a whole 9 ticks.
Data out on Thursday had shown US economic growth was quicker than initially forecasted in the third quarter, but disappointing numbers on personal spending and income pointed to a slowdown in the present quarter. The dollar rally has been fuelled in part by bets that the incoming Trump Administration and a Republican-controlled Congress would slash taxes and boost debt-funded spending, pushing up inflation and bond yields.
Currently two-year US paper offers a plump premium of 198 basis points over German debt, up from 144 at the start of November and near the widest since 2005. "Yields spreads should attract more capital into the USD," said Ray Attrill, global co-head of FX at NAB.
"Monetary policy divergence is set to be more pronounced in 2017 with Fed tightening while BoJ, ECB and BoE further expand their balance sheets," he added. "FOMC risk is skewed to the Fed doing more, not less, than the 60 basis points of tightening currently priced." Indeed, the Bank of Japan and European Central Bank are actively working to keep their short-term yields deep in negative territory, widening the gap even further.
Yet Attrill also saw reasons why the dollar might not rise as far as some bulls expect. He argued the dollar rally already fully reflected the widening in spreads since Trump's election and a further sharp increase in US yields could start to weigh on stocks and the economy, drawing resistance from the Federal Reserve.
"We aren't expecting 10-year US yields to make a sustained move above 2.75 percent in 2017. This is more consistent with a 3-5 percent rise in the USD than 10 percent." Elsewhere, the Italian government approved a plan for the rescue of Monte dei Paschi di Siena after the world's oldest bank failed to win backing from investors. If the package is seen as credible it could lessen one drag on euro sentiment.
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