A major reversal in currencies is happening right now; Trump’s tax plan is moving the dollar.
A Hawkish Fed And Economic Stimulus Lift The Dollar
On Wednesday comments delivered by Federal Reserve Open Market Committee Chairperson Janet Yellen sent the dollar to a one month high. Today news out of Washington has lifted it further on stimulus that for once is focused on legislative change versus central bank policy. Yellen’s comments, to the effect that the Fed had misjudged inflation and employment, sent a jolt through the market as interest rate hike probability jumped nearly 10%. Trump’s tax plan, leaked in the early morning hours, did the same as the administration takes another step closer to the economic package promised during the campaign.
The plan, drafted by the “Big 6”, is focused on lowering taxes for businesses and individuals but still faces sharp opposition from Democrats and criticism from economists. The democrats are focusing on tax for big businesses and the wealthy, seemingly at odds with the pledge to lower taxes on the middle class, as well as potential loopholes the wealthy could use to take advantage of lower rates. Despite the opposition there is broad support among republicans.
The plan aims to cut the corporate tax rate to 20% from 35% with pass through S-type corporations paying 25%. The pass-throughs are now taxed at the individual rate. The number of tax brackets will be reduced from 7 to 3 with the top end at 35%, 4.5% below the current top rate. There is wording to allow a 4th and higher bracket if necessary to get the deal done. The mortgage interest deduction was left alone to the satisfaction of home owners but those for state and local taxes were removed. To counter this the standard deduction has been doubled along with an increase to the child tax credit.
Another major criticism is how the plan will be paid for, it is estimated to cost $1 trillion in revenue. So far, details on that are sketchy but there is an expectation from within the administration that the cuts will in most part pay for themselves. The idea is that tax cuts will free cash within the system, allow businesses and investors to keep more of their capital and lead to increased economic activity.
The Dollar Index extended its weekly gains on the double shot of good news. The EUR/USD extended its fall from long term resistance at 1.2000 to trade at a 1 month low near 1.7250. The move also extends a break below a major up trend line and is now approaching a potential target for support. The indicators are bearish, moving lower and convergent with the new low suggesting that prices will continue to fall in the near term at least. Support target is just below 1.6750, a break below which would be bearish in the longer term.
The USD/JPY gained nearly a full percent in the wake of Yellen’s comments and the lead up to the tax plan announcement. The pair created a medium-long bullish candle confirming continuing of the near term trend. Price action has broken near term resistance to set a new 2.5 month high with bullish indicators. A continuation of this move may find next resistance at the top of the short term trading range near 114.50.
The next hurdle for the dollar to cross is Personal Income and Spending and Core PCE Prices data on Friday. This data is the Fed’s preferred gauge of inflation and could give further insight into forward expectations and rate hike timing. To date the PCE and the core PCE has been running at a rate below the FOMC’s target 2% despite a brief spike above 2% earlier this year. What traders need to be wary of is higher oil prices, the spike in inflation earlier this year coincided with a peak in oil prices and oil prices are now approaching those same levels. Any increase in PCE, coupled with the economic stimulus of Trump’s tax plan, will likely push the dollar higher versus the other major world currencies.Trade on USD
NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.
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