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Markets shift attention from Trump towards Fed

The US dollar and global bond yields rose on Wednesday as investors focused on expectations that the Federal Reserve wants to raise interest rates this month, in the absence of specific policy details from Donald Trump’s first speech to Congress.

The dollar index — a measure of the reserve currency against its main peers — rose 0.5 per cent to its highest level in more than a month as investors were primed by comments made by New York Federal Reserve president William Dudley on Tuesday that the case for a US rate increase had become “a lot more compelling”.

Markets now ascribe an 80 per cent chance of the US raising interest rates when policymakers meet in mid-March, according to Bloomberg data on federal funds futures, up from just 36 per cent last week.

With Mr Trump failing to provide specific policy details about stimulus proposals, financial markets are looking ahead to a speech on Friday by Fed chair Janet Yellen.

“With the financial markets increasingly pricing in the probability of a rate hike in March, there is certainly a much greater chance that Yellen’s speech on Friday may well support that logic,” said Derek Halpenny at Bank of Tokyo-Mitsubishi UFJ.

Bond traders boosted the odds of a rate tightening in two weeks’ time after Mr Dudley said in an interview with CNN late on Tuesday that policymakers did not need to wait for tax reforms to be in place before taking action, flagging up economic growth and job creation.

The central bank’s positive outlook on US inflation and growth provides another spur to the reflation trade that has extended from the US to become a global phenomenon.

As stock markets in Europe and Asia showed modest gains, government bond prices weakened, following the tone set by US Treasuries. The yield on two-year US Treasury notes, which are particularly sensitive to interest rate expectations, peaked at 1.30 per cent, up from a low of 1.18 per cent on Tuesday. Equivalent German bond yields climbed 3 basis points on Wednesday morning.

Emerging market currencies were mainly firmer against the dollar on Wednesday, reflecting the lack of trade protection rhetoric from Mr Trump when he addressed Congress.

When US markets open on Wednesday, equity index futures suggest the S&P 500 will recover from a modest loss on Tuesday before Mr Trump’s address.

The world’s largest equity index, the S&P 500, set a record high in the days leading up to Mr Trump’s address, as investors anticipated more detail on the administration’s plans for pro-growth policies of tax reform, deregulation and infrastructure.

“There was little in the way of fresh content for the market to trade off,” said Richard McGuire, rates strategist at the London office of Rabobank. “Given this, all focus instead turned to the slew of hawkish rhetoric from Fed speakers.”

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