Commodities Rally As Dollar Demand Cools

European equity markets are poised to get the week off to a slightly positive start on Monday, boosted by some decent gains in commodity markets which are being supported by the dollar rally finally losing some steam.

Fed rate hike expectations have risen considerably since the election as one of the major hurdles to a rise passed relatively smoothly, triggering a relentless rally in the dollar to trade at its highest level in more than 13 years. With a December hike now 95% priced in, according to CME group, it seems the dollar trade may be experiencing a temporary cooling, although with markets still only pricing in one hike next year, I think there could be more to come down the road.

FedWatch Chart

We’ve heard from a number of different Fed officials over the last week, some of which have hinted that a hike will come in December, while others have been far more direct claiming only significant negative news could derail it, or that we would have to have a surprise for it not to happen.

While the dollar has made substantial gains against most of its peers in recent weeks, this has been particularly the case against the yen, where the Bank of Japan’s 0% yield policy on 10-year JGB's has turned out to be extremely effective so far.

The widening yield differential between 10-year Treasuries and JGB’s has sent the dollar flying against the yen to trade above 111, from as low as 101.19 after the election a couple of weeks ago. As long as the market continues to buy into the BoJ’s commitment to keeping yields at 0%, it seems Japanese officials will finally get their wish of a weaker yen.

USD/JPY Daily Chart

The cooling dollar demand could continue to support commodities today, some of which have been battered by the sudden changes in interest rate expectations while others have received a considerable boost by the promise of infrastructure spending by the Trump administration. Oil is already more than 1% higher on the day, helped by Vladimir Putin’s belief that an output deal will be reached later this month. While loose terms may be agreed, I remain sceptical that a full detailed agreement can be both achieved and carried out by OPEC given the clear differences that are so evident between certain key members.

It’s looking a little light on the economic data front today. We will hear from Mario Draghi later on this afternoon which could be interesting given that the accounts from the last meeting indicated that a decision on QE will be made at the December meeting. Aside from that, we may have to wait until Wednesday for this week’s main events with the UK Autumn statement and US FOMC minutes both being released.

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