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The US dollar jumped 0.5% (DXY basis) last night before the US equity markets closed on the back of President Trump calling an end to negotiations between his party and the Democrats over a fiscal stimulus package. There has been little followthrough on Wednesday however given President Trump appears to have backtracked by stating he is ready and willing to sign certain elements of support. Economists at MUFG Bank see downside risks for stocks and upside risks for the greenback as the US stimulus hopes fade while Fed concerns rise.

Key quotes

“The prospects of a deal were already diminishing simply given the fact that Republicans themselves in the Senate are divided on the size of another stimulus package. A piecemeal deal that focuses on the areas that please President Trump most and does not address the main concerns of the Democrats will never get through the House and hence, despite this backtrack from Trump offering hope, we see the prospect of a deal diminishing further. So we are somewhat surprised by the level of hope the markets appear to be clinging on to and continue to see downside risks for equities and upside risks for the US dollar.”

“The lack of progress on a deal is all the more alarming when we hear the clarity from the Fed on the need for additional support. The message from Powell on fiscal stimulus might not be particularly new but you can sense the level of urgency has gone up. With the recovery far from complete, it would be “tragic” to allow weak momentum to take hold and that the risks of policy intervention were asymmetric with too little support leading to ‘unnecessary hardship’. With no deal before the election, a further five months at least without additional fiscal support lies ahead.”

“Ideally, the Fed would have preferred to have upped QE on the back of additional fiscal stimulus in order to keep yields in check. That would have been a powerful overall policy stimulus, helping drive inflation expectations higher and real yields and the dollar lower. But now the risk is that the Fed is forced into additional QE as a counter to the poor fiscal policy outlook. If that’s what happens, it will not have the same impact on lifting inflation expectations or weakening the US dollar.”