The U.S. dollar is performing well against all of the major currencies this morning thanks to the rise in U.S. yields. Ten-year Treasury yields are trading within a basis point of 2.95% and by next week we expect yields to break 3%. The Federal Reserve's decision to begin its long farewell with Quantitative Easing marks a significant change in U.S. monetary policy. While Janet Yellen's Senate Confirmation hearing has been postponed to January 6, there's no question that she will become the next head of the Federal Reserve and her support of this week's decisions suggests that she may be less dovish next year.
Strong U.S. Data
Persistent improvements in U.S. data continue to give the Fed confidence that they have made the right decision with unwinding QE. Third quarter GDP growth was revised up to 4.1% from a previous forecast of 3.6% and we can't forget that the initial forecast was 2.6%. Between July and September, the U.S. economy grew fast than most policymakers and economists anticipated because the U.S. government shutdown did not do significant to consumer consumption. A large part of today's revision can be attributed to stronger final demand as the personal consumption component of the report was revised up from 1.4% to 2%. We expect the U.S. recovery to gain momentum in 2014, keeping the central bank on track to taper at almost every meeting next year, bringing QE to a halt by the end of 2014.
The gradual unwinding of stimulus makes the current uptrend in the dollar one that should last well into the New Year. We expect the greenback to perform the best against currencies whose central banks are dovish and looking to ease further - namely JPY, EUR and AUD. We continue to look for USD/JPY to break 105 and the EUR/USD to drop below 1.35. While the Bank of Japan left monetary policy unchanged last night, there was one minor tweak in the statement that made the overall decision more dovish. The central bank now sees the year over year increase in CPI likely to rise "for the time being" compared to "gradually," which suggests that they expect a slower increase in inflation in the near term.
Meanwhile the Canadian dollar dropped to its lowest level in 3 years on the back of weaker retail sales. Consumer spending fell 0.1% in October but the decline was driven largely by softer demand for autos because sales excluding autos rose 0.4%. The underperformance of Canada's economy and the neutral policy stance of the central banks hit the loonie hard but the weakness of the currency should help to turn things around.
Kathy Lien, Managing Director of FX Strategy for BK Asset Management.