USD: Better placed later in Q4 - Westpac

It’s not obvious that the USD is on the cusp of a durable rally right now, later in Q4 looks much more conducive for the USD, according to analysts at Westpac.

Key Quotes

“We would highlight two main issues for the USD near term:

1. Debt ceiling and government shutdown risk runs high in Sep and Oct. The conservative House Freedom caucus once again want spending cuts in exchange for their debt ceiling vote. To avert a technical default Republican leaders need to craft a bill that attracts Democrats. But, in the hyper-partisan climate, Democrats will push for their agenda in exchange for their vote, measures that will result in a loss of Republican votes. All told stalemate is certain and the deadline is tight.
2. EUR is unlikely to fall materially until the ECB delivers on tapering (i.e. “buy the rumour sell the fact”). The USD during the 2013 taper tantrum is instructive. Bernanke first mentioned tapering in May 2013 and the Fed formally announced the policy Dec 2013. The USD and yields were well supported in that entire period and beyond, into Jan 2014. But, with tapering all but priced in by then, the USD reversed course Jan-May 2014. EUR and bund yields may well behave similarly. Draghi said tapering could be announced in “Autumn”, spotlighting their Oct 26 meeting. If the USD in 2013 is any guide that implies euro remains well supported into that ECB meeting and a meaningful correction is unlikely until it is out of the way.”

“Also, seasonality is much more fortuitous for the USD in Q4 than Q3. Q3 is usually a checkered one: the USD has shed ground in 6 of the last 10 third quarters but has risen in 8 of the last 10 fourth quarters.”

“The USD is unlikely to mount an effective rally even with the tailwind from firmer data given seasonals and with the ECB yet to make a formal tapering announcement, not to mention Washington gearing up for another showdown over the debt limit in Sep/Oct.”

“Later Q4 looks much more fertile for the USD – by then these key event risks will have been negotiated, seasonals are much more supportive and Washington will begin focusing heavily on tax cuts.”