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US Dollar Clears Fed Threat, Ready to Run if Fear Erupts

US Dollar Clears Fed Threat, Ready to Run if Fear Erupts

John Kicklighter, Chief Strategist
US_Dollar_Clears_Fed_Threat_Ready_to_Run_if_Fear_Erupt_body_Picture_5.png, US Dollar Clears Fed Threat, Ready to Run if Fear Erupts

Fundamental Forecast for US Dollar: Bullish

How do you define a bullish and a bearish market? From a technical perspective, that answer is relatively easy. There are plenty of options from trendlines and moving averages to momentum and Elliott Wave projects that we could use to define our market. From a fundamental perspective, the answer is just as simple and perhaps more profound. A bullish market on this level is one that is more receptive to positive developments while the influence of negative events is discounted, and vice versa. For the dollar, this means that when the market is more sensitive to risk aversion trends rather than those developments that encourage speculative build up; the greenback is ready to rally. The first half of June reflected hope amongst the speculative ranks despite a range of negative data; but the Fed’s refusal on QE3 may represent a critical turning point in that fundamental bearing.

The magnitude of this past week’s fundamental shift cannot be overstated – even though risk trends didn’t provide the immediate flush of recognition that we so often desire. For two weeks, forecasts for growth declined, market-based yields slid and the Euro-area financial crisis continued to evolve into a communicable contagion. And yet, equities and carry continued to rise. When the Federal Reserve announced that it would not fulfill bulls’ hope for additional asset purchases – QE3 – market participants were forced to review the validity of the June climb and the suitability of the tumble from May.

For the US dollar alone, the realization that the central bank wouldn’t flood the system with more dollars (an outcome of stimulus that increases the balance sheet) was a meaningful relief. Some may argue that the $267 billion extension of Operation Twist weighs on the dollar as it weighs longer-term rates of return. But, with 10-year yields already plunging record lows and the Fed committed to its mid-2014 commitment to keep the benchmark rate near zero; this adds little to the existing argument.

What the Fed decision this past week equates to lifting a weight off the greenback. Without the immediate possibility that the world’s largest central bank will swoop in with another massive funding effort to prop up capital markets, the most volatile buffer to risk aversion has been lifted. For the safe haven dollar, that is a good thing. That said, there is a difference between taking off the brake and actually stepping on the gas. There may have been plenty of catalysts these past two weeks that could have driven risk aversion had Fed expectations not impeded the market’s volatility, but now we need to look to fresh catalysts to provide heat.

Looking out over the upcoming week, there are a number of noteworthy economic releases on the US docket (consumer confidence, new home sales, personal spending and durable goods among them), but these don’t tap into the bedrock of risk trends. Another week forward, we will star the 2Q earnings season – an event that could remind investors what happens to revenue and investment when growth slows – but that isn’t a catalyst for next week.

Appraising the big sentiment swings over the past months, US developments really haven’t driven speculative positioning (they have curbed it). The Euro Zone’s financial trouble and the threat that it can make the jump to a global pandemic will be the leading concern. That being the case, however, we may have another situation on our hands where hope and expectation can curb active risk positioning. The EU Summit is scheduled for Thursday and Friday, and many believe this is a make-or-break meeting for the Euro Zone.

- JK

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.