US Dollar Stable Despite Sharp Deterioration in Fed Rate Expectations - Reversal Ahead?

Dismal Jobless Claims and New Home Sales figures further cut optimism on the future of US economic expansion, completely offsetting upward revisions to third quarter US Gross Domestic Product growth. The US economy grew at its fastest annualized pace in four years through the third quarter, but economists subsequently expect that economic activity will decelerate through coming quarters. Indeed, the ongoing housing recession and financial market duress are predicted to drag fourth quarter growth rates to as little as 0.3 percent according to some major research desks.

A bearish outlook on the future of economic expansion has translated into forecasts for further Federal Reserve interest rate cuts, and indeed Fed Funds rate expectations moved significantly lower through the trading session. The implied yield on the December Fed Funds Futures contract fell a whopping 4.5 basis points to 4.24 percent, while the yield on the January contract dropped a similarly substantial 6.0bp at 4.17. Futures traders are, by extension, pricing in a 30 percent chance that the Federal Reserve will cut interest rates by 50bp at their upcoming meeting—up from a mere 6 percent chance seen yesterday. All else remaining equal, this should be enough to sink the US dollar against major forex counterparts. Yet the greenback’s resilience suggests that traders are yet unwilling to push the currency to fresh depths.   

A recent shift in speculative currency trader positioning suggests that dollar selling may slow through short-term price action, as our proprietary FXCM Speculative Sentiment Index now calls for a potential dollar rebound in the days ahead. According to a sample of retail forex positioning, orders to sell the US dollar against the Euro surged nearly 40 percent since last week. Such shifts have historically brought subsequent US dollar rallies and suggest that the recent EURUSD correction may continue in the days ahead. To see a full report on currency trader positioning, see our weekly FXCM Speculative Sentiment Index Report.

Written by David Rodríguez, Currency Analyst for DailyFX.com