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Where does the dollar go from here?

Recent dollar strength in the wake of the US election brings about the potential for further gains. With the Federal Reserve likely to raise rates soon, what will the coming weeks and months hold for the greenback?

Traders on the NYSE
Source: Bloomberg

Yesterday saw the final piece in the jigsaw for the US economic outlook, with a whole raft of recent economic data only becoming relevant once we saw the result and reaction to the US election. The likeliness of a Fed hike shifted considerably overnight, at one point falling below 50%. However, with the recovery in risk assets highlighting a wider market confidence, the chances of a rate hike have improved considerably, now up to 82%.

The chart below highlights the improved fortunes of the US jobs market over the past year, with payrolls largely stabilising, into the range historically seen when seeing unemployment around the current levels. With that in mind, there appears to be little in the jobs market to hold the Fed back from raising rates.

US jobs market chart

Next, looking at inflation and growth, we are seeing a less convincing story, with all readings improving in a more gradual manner. Nevertheless, with global inflation turning higher, there is a fear that now we have turned, we could see a rampant rise in prices. This is especially so in the likes of the UK, where currency devaluation will spark cost push inflation for UK producers and imports will also cost more.

Nonetheless, the US has its own problems, with Trump promising to raise tariffs on Mexican and Chinese imports, thus raising inflation. That may not come to fruition, but it is a potential event which the Fed will have to consider when deriving expectations.

Growth and inflation chart

The Fed has come under a significant degree of slack from Trump over its willingness to keep rates low for as long as it has, apparently doing so to help Clinton take the presidency. While the Fed is supposed to be independent, previous pressure to act will likely drive Fed members willingness to finally raise rates, especially given the recovery in stock markets.

All in all, we have a picture where markets are feeling bullish for the US economy and the Fed is likely to provide yet another December rate hike. This provides a bullish backdrop for the dollar, which has been gaining as a result. Looking at the dollar index, we continue to trade within a range that has been in play for 21-months now. With expectations of further dollar strength, it is likely we will reach the 100 mark before year end (Fed dependent).

This is likely to have significant implications for the FX markets, which typically trades currencies against the dollar. As such, watch out for a potential bullish dollar story over the coming weeks, with a break through 99.05 on the dollar index likely to spark another leg higher over the near-term.

Dollar price chart

The EUR/USD chart looks very similar, with an M-shaped pattern in play. Despite the sharp appreciation yesterday, we have seen the pair move back on trend, pointing towards potential a move back into the $1.07 region before long. On this occasion, we are looking for a closed candle below $108.51 to signify the beginning of the next extension lower.

EUR/USD price chart

IN_USDJPY has also shown signs of strength. Bearing in mind that we have been trading within a downtrend through 2016 so far, the break through ¥104.32 recently was a convincing sign that we could be reversing higher. Up ahead lies the ¥107.49 resistance level. A break through there and we will see a much more convincing reversal signal for traders to jump on.

USD/JPY price chart

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