A Weaker Dollar

Last week saw the resolution of 3 major issues that had weighed on the stock market -- US/China Phase 1 trade agreement, likelihood of near-term Brexit after Boris Johnson's election victory, and clarity on the Fed's expectations for monetary policy in 2020.   All three resolutions are positive for the stock market.  And, a Christmas rally that persists into January seems likely.  But, they all have one implication that is negative for Treasuries (in terms of price) -- a weaker dollar.

While analysts may debate whether the US/China trade resolution is meaningful or not, it does eliminate for now the risk of a worsening trade war.  So, there should be an unwinding of a "flight to safety" demand for dollars.  Also, any expected widening of the US trade deficit as a result of the reduction in tariffs will put downward pressure on the dollar.

The euro and pound already have begun to strengthen as a result of Johnson's victory.  The reduced likelihood of an abrupt dropping out of the UK from the Euro Area is a positive for the business outlook there, which should help lift these currencies versus the dollar.

The Fed's expectation are for steady monetary policy in 2020 despite an expectations for above-trend GDP Growth  and higher inflation.  This inflationary policy stance should hurt the dollar. 

The Fed's policy stance and the weaker dollar have inflationary implications.  So, they are negatives for the long-end of the Treasury curve and could result in a further steepening in the  yield curve.  

While the Impeachment Inquiry is a non-event for the markets, as it is expected to be defeated in the Senate, the decline of Elizabeth Warren and Bernie Sanders in the polls already may have contributed to the steepening of the medium-term Treasury yield curve.  Their disruptive policy ideas have become less likely to be put into effect during the next 5 years.

With longer-term Treasury yields already back up, and with the risk that they will rise further next year, any strength in this week's housing-related data releases will likely be ignored as temporary.  November Industrial Production also should be largely discounted as one-off -- it should jump as motor vehicle output bounces back from the GM strike.  European Markit PMIs need to rise by more than the modest increases seen by consensus to be significant.

More important for the outlook will be whether forward-looking manufacturing-related data improve, due a week later.  In particular, increases in Core Durable Goods Orders (Non-defense Capital Goods Excluding Civilian Aircraft) would show that the drag from the trade war is dissipating and would move in a direction that eliminates one of the negative risks -- weak capital spending -- in the outlook seen by the Fed.  Higher oil prices also should work not only to lift inflation but to spur increased oil drilling -- which feeds into Business Investment in GDP.