US Dollar Struggling to Avoid Collapse through Risk, Rate Speculation
The lynchpin to the dollar’s ability to span both extremes of the risk spectrum is the interest rate outlook. The United States is already considered to be ahead of the curve for economic recovery; however, the implications expansion has for yield (or expected returns on capital invested in the US) requires tangible results. On this front, the forecast for monetary policy has improved considerably over just the past few weeks. In fact, overnight index swaps from Credit Suisse are pricing in approximately 88 basis points worth of rate hikes over the coming 12 months – the most hawkish forecast in a month and notably more bullish than the outlook for the ECB or BoE. This establishes pace; but establishing a stable role for the dollar at the upper echelons of the yield curve is the timing of the first rate hike. This past week, the Federal Reserve discouraged rate hawks by maintaining its warning that rates would remain “exceptionally low” for an “extended period.” However, this does not necessarily put the dollar at a disadvantage. The removal of this phraseology would likely set expectations for the first tightening of the Fed Funds rate to a time frame of two to four meetings following the announcement. This matches up reasonably well with the remarks being dropped at the April gathering given Fed Fund futures have priced in approximately a 50 percent probability of a hike in September and a 67 percent chance of rates rising to at least 0.50 percent by November. In the meantime, the FOMC continues to tighten the policy reins in other areas. Lending facilities established to support liquidity through the financial crisis are scheduled to expire at the end of the month and speculation is running high of a follow up hike to the discount lending rate.
While rate speculation develops in the background, the dollar will remain especially sensitive to large swings in sentiment trends. Looking ahead to next week, there are potential catalysts for the UK (the 2011 budget release) and Euro Zone (the deadline for a Greek bailout plan). Beyond these known events, it would not be out of the question to see an unexpected progress report from China on its asset bubble, the US on its deficit fight or one of the credit rating agencies. Given the capital markets’ rise to new highs recently, the scene is ripe for a bolt of uncertainty to shake unabashed speculative build up. In the meantime, the US docket itself is light. The Chicago Fed’s National Activity Index is notable for its scope; but it lacks market moving impact. The same can be said about the durable goods and home sales figures – though all this data should be mentally processed for its impact on growth expectations. - JK
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