USD on Shaky Footing at the Start of FOMC Week
- EURUSD holds above $1.1300 after better EZ production data.
- See the September forex seasonality report.
Realistically, the Fed has one of two options this week, and neither bode well for the US Dollar.
The first option would be for the Fed to raise rates, and announce that it would not do so again until its inflation half of the dual mandate is met. FX markets continually discount future policy actions, and an indication that the Fed wouldn’t be looking to raise rates any time soon would undermine the US Dollar.
The second option would be for the Fed to not raise rates at this meeting, and at the moment, markets are pricing in December as the most likely period for the first rate rise (per the Fed funds futures contract). A meeting that unfolded in this manner could conjure memories of the March FOMC meeting, in which the US Dollar depreciated sharply after the Fed bluffed the beginning of its normalization process.
It seems the only safety net that the Fed could offer the US Dollar this week, in absence of a rate rise, would be for crafting forward guidance to signal a rate hike in the immediate future; traders looking forward to an October or December rate move may already be factoring this in, considering there is only a 28% chance of a rate hike in September and a 56% chance in December (per the Fed funds futures contract).
In any case, the driving force fueling the US Dollar’s potential decline post-FOMC would be derived from diminished expectations for future policy action. One such place to look for evidence of this will be the Fed’s dot plots, in which Fed members indicate where they believe the main rate will be at various points in time. The June forecasts implied one or two rate hikes in 2015; the decision to do a “one and done” hike or delay it to the October or December meetings will further lower the projected rate path; reduced rate expectations will hurt the US Dollar.
Current positioning bodes poorly for the US Dollar, too. The retail trading crowd has recently increased its net-long USD positions; typically, we prefer to stay on the otherside of the crowd. Likewise, per the CFTC's most recent COT report, speculators/non-commercials held 53.4K net-long Dollar Index (DXY) contracts, 81.2K net-short Euro contracts, 53.3K net-short Australian Dollar contracts, and 48.6K net-short Canadian Dollar contracts; in aggregate, the market is net-long the US Dollar, with a veritable source of fuel for short covering in several of the major currencies.
--- Written by Christopher Vecchio, Currency Strategist
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