The US Dollar's Moment of Vulnerability
October, a seasonally bullish month in the QE era of monetary policy, has been anything but for the US Dollar. This past week was potentially disastrous. The market was previously embracing the classic 'risk off' mentality; now it may be embracing the once-thought extinct 'QE on' mentality.
We flipped back to a state of 'long risk, short USD and JPY' yesterday after Bloomberg News broke an interview with Fed President James Bullard in which he stated that more QE might be a possible policy outcome, depending on recent shifts in data and global affairs.
The US Dollar's role in the Fed's soon to be more prominent dovish shift is not all that minor. Ahead of the September FOMC minutes' release on October 8, we noted that the 12-week bull run coincided with a rise in concerns over falling inflation expectations. That set of minutes made the Fed's concern over US Dollar strength very clear:
"While most viewed the risk that inflation would run persistently below 2 percent as having diminished somewhat since earlier in the year, a couple noted the possibility that longer-term inflation expectations might be slightly lower than the Committee's 2 percent objective or that domestic inflation might be held down by persistent disinflation among U.S. trading partners and further appreciation of the dollar."
Now that the retail crowd has shifted positioning to long US Dollar positions, the appeal of being a greenback bull at these levels is less appealing. If the Fed's Bullard is the start of a new wave of dovish Fed policy aimed at tethering the US Dollar to a meaningful level such that inflation expectations can rebound, then there will be more selling ahead.
--- Written by Christopher Vecchio, Currency Strategist
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