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FUNDAMENTAL ANALYSIS

Corrective Forces Emerge, but Underlying Trend is Evident

Corrective, Forces, Emerge, Underlying, Trend, Evident, fundamental analysis, fx trader, forex

25 Nov 2016

The US dollar's recent gains are being trimmed today, and it is down against all the major currencies. Many emerging market currencies, including the Turkish lira, Indian rupee, and Hungarian forint are firmer today.

The dollar's losses are minor, and the forces that drove it higher remain intact. One of the most important of these drivers has been the increase in US interest rates, and the US yields 2-3 bp higher today. The recent string of economic data leaves the Fed set to hike rates next month. Next week's November employment report is seen as the last potential hiccup on the way to a rate hike. However, most are looking for an improvement in job creation after a 161k increase in October.

The other important driver has been the anticipation that the populist-nationalist rise will be expressed shortly in Europe. The Italian referendum and the Austrian presidential election next week may be a dress rehearsal for the French Presidential election next spring. The center-right Republicans will have a run-off between a self-styled Thatcher-esque candidate (Fillon) and the old guard (Juppe). Perhaps obscured by the pressure on Italian bonds, the French premium over Germany continues to trend higher. It is near 54 bp today, the widest since Q1 2014. As recently as July, the premium was near 20 bp.

There has been no fundamental news development that is spurring today's modest correction. The main data has come from Japan. At the headline level, Japan's CPI, on a year-over-year basis rose to 0.1% from -0.5%. It is the first reading above zero since February. However, it exaggerates improvement. What the BOJ calls the core rate, excludes fresh food, and on a year-over-year basis, it remained -0.4%. It has been negative for eight months, which is the longest deflation streak since 2009-2011.

What happened in October is that because of the typhoon and poor weather, fresh food prices rose by nearly 11.5%. We can be confident that the upward pressure on fresh food prices will not be sustained. At the same time, there was another encouraging sign that deflation may be ebbing. The measure of Japanese inflation that comes close to the US core rate, which excludes both food and energy rose from its lowest pace since September 2013 (of zero) to 0.2%.

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