Fading hopes for tax cuts may undermine USD gains

The US Dollar managed to emerge unscathed from a week full of potential pitfalls. The FOMC policy announcement did not degrade the likelihood of a December rate hike, top-tier economic data outcomes continued to look broadly supportive and Donald Trump opted for a seemingly steady pair of hands in nominating Governor Jerome Powell as the next Fed Chair.

The week ahead is short on eyecatching statistical releases, with the University of Michigan consumer confidence report being a sole exception. The Fed-speak docket is a bit more engaging, offering a speech from newly minted Vice Chair for Supervision Randall Quarles. Still, with the central bank’s next move largely priced in, the market-moving potential here might be limited.

The rate hike path in 2018 is likely of greater speculative interest. Fiscal policy is the central unknown on this front. The Trump administration has championed an aggressive round of tax cuts before year-end, which investors expect will be inflationary if it enacted. That would likely force the US central bank into a more aggressive tightening cycle, linking the US Dollar’s fortunes with the legislation.

An initial proposal for the reform introduced by the Republican leadership in the House of Representatives failed to impress last week several GOP lawmakers broke rank to oppose it. Compliance with Senate rules for a simple-majority vote - which would allow Republicans to pass the plan along strict party lines - is also likely to mean significant revisions.

That means the markets will be keen to size up the Senate version of the proposal due out next week. Substantive differences with the House version seem almost inevitable. This may translate into a week of seesaw volatility for the greenback as investors comb through incoming headlines to establish the probability of speedy reconciliation.

If the tax plan seems to be going the way of a multitude of aborted efforts at healthcare reform, the US Dollar may be pressured. The degree of any weakness may be a telltale sign of what to expect through year-end. If the markets are content enough with the Fed’s own cautiously hawkish stance and the currency’s uptrend survives disappointment on the fiscal side, its prospects will meaningfully brighten.

We remain neutral on GBP at the current juncture but events next week may offer Sterling bulls comfort and a second chance to enter long positions. Against the EUR, JPY and NZD - currencies whose current fundamentals are seen as neutral or weak - any advances in Brexit negotiations, leading to the UK being allowed to open trade discussions with EU members, will see GBP strengthen sharply and put the lows seen in the last 12-14 months firmly in the rear mirror.

And next week, UK Brexit negotiators David Davis and his EU counterpart Michel Barnier will continue talks with both sides stating recently that they are keen for talks to speed up, a sign that both parties may be willing to compromise to avert talks falling off a ‘cliff edge’. And with the clock ticking - to borrow one of Mr. Barnier’s phrases - talks will need to move forward as a hard-Brexit will cause both the UK and EU serious economic damage in the short-term.

EUR/GBP is currently wedged between two Fibonacci retracement levels - 0.89215 and 0.88024 - of the April 17-August 29 range. A break to the downside would see the July 14/17 double low around 0.87445 the next target which would open up a move to 0.86928. On the upside, 0.9022 and 0.9033 remain firmly in play if talks continue to stall.

The Australian Dollar will face a monetary-policy decision from the Reserve Bank of Australia in the coming week, but that may not provide it with much support, if any.

The key Official Cash Rate still languishes at the 1.50% record low which has endured since August 2016. It’s certainly not expected to change on Tuesday when the RBA gives the word.

Now, many other developed market central banks have either tightened monetary policy this year or signaled some intention of doing so. But the RBA has not. What’s more it has explicitly denied that rate rises elsewhere in the world place any burden upon it to follow. One of its officials even said in early October that rates could even go yet lower. That’s not market consensus, of course. Interestrate futures markets think that the next move, when it comes, will be an increase. But they don’t now fully price one of those until the start of 2019.

Why the reticence? Well, the RBA’s dilemma was nicely underlined last week. Australia’s external, export machine is firing very nicely as the latest trade numbers showed. But commensurate vigour remains lacking in the domestic, consumer sector. There retail sales missed forecasts, while wages remain subdued and consumer debt is eye-wateringly high.

Unless the Reserve Bank has had a dramatic change of heart this month, it can be expected to stick with old themes. That will mean an acknowledgement of the Australian economy’s strengths as well as a frank admission of its weaknesses, probably accompanied by some loud grumbling about the baleful effects of too much currency strength.

Against this backdrop it is hard to see AUD/USD making much headway under its own power. Disappointing US economic data may of course shift the dial in the Aussie’s favour. But the trouble is that we are at that part of the month in which the US data cycle winds down after the crucial official labour-market release. There simply isn’t enough first-tier information on tap in the coming sessions.

The price of Crude Oil is set to rise another week, making it the fourth advancement of both WTI Crude and ICE Brent Oil. In late trading on Friday, WTI Crude Oil rose to the highest intraday level since July 2015. After a weak start to October, the price of crude has risen aggressively alongside base metals on a comparable convergence of demand beginning to outstrip supply. OPEC’s annual meeting in Vienna later this month will be a key event where the leaders of OPEC are expected to agree on

A key driver of higher crude oil has been the expressed view by OPEC’s largest exporter, Saudi Arabia’s oil minister, Khalid Al-Falih, who said the “Mission is not accomplished.” Traders should note that this was said as Brent (the global oil benchmark) traded at 27-month highs as producers pump less leading to lower output and higher prices. From a strategic perspective, OPEC+ (a moniker for OPEC and key allies like Russia) appears to be taking the long view, which has been validated by the forwards curve.

The forward curve in Brent is showing the most bullish view in nearly three years as the lowest point through 2019 is at $56, which lifts the floor of expected future Brent prices. Much of this rising forward curve is based on signs that OPEC will agree to extend the curb production pact either six or nine months after the deal expiry of March 2018. In the US, a positive weekly EIA Crude Oil Inventory Report showed the glut appears to be over as Oil stockpiles fell to a twoyear low as exports, hit a new record last week showing the pick-up in global demand.

Lastly, earnings from big oil firms were undoubtedly positive and optimistic as Q3 earnings hit the market in recent weeks. In addition to confidence that OPEC will back an extension in production curves, Oil service companies see higher prices and higher demand on the horizon forecasting an increase in earnings. Now the equity prices of oil companies are aligning and catching up to the price of the product they discover, refine and/ or deliver.

Now, on to the charts. The price of crude oil continues to move higher and hug the top of a channel drawn off the July low of $42.03, and the initial high in the channel from the early August high of $50.43. There is a broader channel drawn off key pivots from 2014 and early 2015 that favor price resistance near $56.50. Lastly, a Fibonacci extension favors a potential push toward $59.08. Given the momentum of positive fundamental developments and supply falling against demand growth, we could see this ‘extreme’ level tested and broken before year-end.