Interest rate differentials starting to bite

The Euro fell to its lowest level in three months versus the dollar yesterday as the cost of holding long euro positions drove trader’s concerns. Over the ten years since the global financial crisis, carry costs and the infamous carry trade have lost all significance but as the FOMC embarks on a far more hawkish path than any of its G7 partners it will become a major consideration for profitability. Long term positions will need to be even more precise as costs will need to be considered.

The common currency reached 1.1553 before recovering on a bout of profit taking. The pound and Euro are both suffering from monetary policy issues although the reason for low rates in the Eurozone is a more positive issue than in the U.K.

If the FOMC can understand why inflation and wage growth continue to fall below expectation it will start to hike rates more quickly, possibly three times in 2018 following a hike in December. This will be a major influence over the markets in the new year and long-term players are already preparing to be long dollars, looking for the right level to open positions.

Brexit talks to resume as EU prepares to get tough

The resumption of Brexit talks between the U.K. and EU tomorrow is likely to see a marked change in the attitude of EU negotiators. The continued prevarication of the U.K. team over the budget contribution following the U.K.’s departure and Theresa May’s assertion that the U.K, will pay what it owes is going to need to be backed up by concrete proposals in Euros and cents if the move to stage two next month is going to be achieved.

Today the EU Commission will meet to agree the terms of reference handed to EU Chief Negotiator Michel Barnier for tomorrow’s meeting. There is a growing hawkish undertone among many EU states over the U.K. trying to enter stage two without agreeing the three issues that the EU raised; The budget, the Irish Border and the treatment of EU citizens remaining in the U.K. following Brexit.

If a delay in the move to stage two is announced as seems to be becoming more likely, Sterling could fall to test its major support at 1.3000. Following last week’s “dovish hike”, monetary policy support has been withdrawn and with the economy barely growing Sterling has very few friendss as things stand.

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Dollar pauses as tailwinds are evaluated

The dollar index rose to a new three month high at the end of last month as several positive influences converged and other G7 currencies suffered their own issues. The prospects for the dollar are clearly positive but traders will now start to await follow through to increase long dollar positions.

The long-awaited tax reform bill is foundering on its path through congress although the President now seems to have moved on leaving the details to his staff. His influence may be necessary although given his relationship with certain Senators his absence from negotiations may be a positive. There is very little talk now of Trump’s highly vaunted economic stimulus package and without any news, it is expected that it has been put back until after the State of the Union address early next year.

Traders have fully priced in a rate hike next month, but it will be how much advance guidance new Fed. Chair Jerome Powell provides that will give a boost to the dollar. Finally, macroeconomic data has been generally supportive but hourly wage increases continue to be an issue despite the improving headline nonfarm payrolls data.

The major economic sticking point is inflation and there are a few FOMC members who are concerned both about the current level and where any increase to justify tighter monetary policy is going to come from.

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