The USD has had a rough start to the year. While uncertainty over the new administration’s trade policies and its ability to implement fiscal plans may be one factor, the bigger issue for the USD, in our view, has been the retreat in US real yields from December’s peak. US inflation expectations have continued to climb, even as Fed expectations and US front-end yields have moderated, pushing real yields lower.
We remain constructive on the USD, but for the currency to recover meaningfully, we will likely need to see more evidence that the surge in manufacturing and consumer sentiment reported in Q4 is translating into actual activity improvement.
So far, December retail and manufacturing data have suggested only a modest expansion, and our forecast for Q4 GDP is below consensus at 1.6% saar. However, we expect activity to pick up in Q1.
As for fiscal policy, it will probably take several months before markets can confidently price for new measures from the Trump administration.
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