Big day for the US dollar

Make no mistake, it's a great day for the US dollar. USD/JPY is up 160 pips to 109.45, making a huge comeback after hitting the lowest since November.

The problem is that it looks like a one-off relief rally. The market is holding a major short position against the US dollar and piled in further on the belief Hurricane Irma would be devastating.

Fortunately for the real world, but unfortunately for US shorts, the storm didn't cause as much damage as feared. So today the dollar is screaming higher.

To me, on the surface it has all the elements of a short-term squeeze; a counter-trend bounce that should be faded.

So what could sustain it:

1) Washington

Dollar bulls bet big on a Republican-controlled Washington this year and they've been battered. The great hope for salvation is on taxes and Republicans badly need a win. Mnuchin and Cohn start a critical round of meetings this week and if that goes well, optimism about tax cuts could take hold, leading to a sustained bid in the dollar. There will be corresponding worries about the deficit but those should be ignored, deficits don't matter to markets right now.

2) The Fed

This one is a longshot. Dudley didn't mention a rate hike this year and I think that's a big indication that December isn't the base case scenario. Still, Yellen won't want to rule it out and the Fed truly believes better US economic numbers are coming. The FOMC is Sept 20.

3) Economic data

The US economy is underperformed this year but I think some quirks have been behind that. There is some underlying strength in housing, business investment and consumer spending that isn't yet showing up. It will come at some point but this week's calendar is thin until CPI on Thursday so there isn't much in the short-term in terms of help.

4) Inflation

I just don't see it on the horizon. Maybe I'm wrong but I think the best hope for inflation is some kind of special-factor quirk that boosts it up 0.3-0.5 percentage points and gets the Fed hawks frothing. CPI on Thursday is expected at 1.8% y/y, up from 1.7% in July.