us_dollar_forecast_pullback_body_Picture_5.png, What Goes Up Must Come Down - Dollar Looks Due Pre-FOMC

What Goes Up Must Come Down - Dollar Looks Due Pre-FOMC

Fundamental Forecast for US Dollar: Neutral

No markets move in a straight line, and the Dow Jones FXCM Dollar Index (ticker: USDollar) fell for the first week in eight as its winning streak inevitably came to an end. Pronounced Japanese Yen weakness was previously enough to push the Dollar Index higher, but early signs of recovery in the Euro, British pound, and Australian Dollar suggest the Greenback may have difficulty hitting fresh peaks on an important week in global economic event risk.

The Dollar uptrend will be put to the test on a highly-anticipated US Federal Reserve interest rate decision, while potentially significant Reserve Bank of Australia and Bank of England meeting minutes could force volatility across key USD pairs.

Traders seemed happy to push the US currency higher on a strong wave of US economic data—particularly following February’s labor and retail sales figures. It made sense to do so as a strong recovery in labor markets could force the Federal Open Market Committee to scale back aggressive Quantitative Easing measures. Yet one-off surprises could prove insufficient ifthe FOMC fails to shift rhetoric on the future of domestic inflation and employment trends, and the US Dollar would likely respond in kind.

The persistent Dollar rally has likewise coincided with an impressive rise in US Treasury Yields, but even the high-flying 10-year Note yield showed its vulnerability on a sharply worse-than-expected University of Michigan Consumer Confidence report. It was the first important data disappointment in some time, but it can hardly be the last. The FOMC statement and official Economic Projections/Press Conference with Chairman Ben Bernanke could dictate how markets react to future economic data surprises.

We like the Dollar’s prospects over the coming months, but an important shift in market sentiment and critical event risk complicates the near-term picture. Indeed, one of our retail sentiment-based strategies recently sold the US Dollar versus the Euro, Japanese Yen, and Australian Dollar. Past performance is notindicative of future results, but said system has had a fair deal of success catching important turning points in the EURUSD, AUDUSD, and USDJPY through recent price action.

From a fundamental perspective it seems the Dollar’s next moves will almost certainly depend on whether the Fed tips its hand on monetary policy and the end of QE. The fact that the Greenback trades near peaks despite fresh records in the Dow Jones Industrial Average is testament to the importance of the unwind in Quantitative Easing expectations. Indeed, it feels a bit unusual to see the USD strengthen on positive US economic data; previously we saw the currency fall on rallies in equity markets and vice versa. Yet market conditions have clearly changed, and we’re in somewhat-unchartered territory as we look to trade the next Dollar moves.

Could the Greenback recover recent losses? Absolutely. Yet we would be express caution in buying the USD versus the resurgent Euro, Australian Dollar, and British Pound in particular. The New Year brought us a sharp jump in currency market volatility and a pronounced Dollar uptrend, but the month of March has thus far seen USD consolidation as traders take a break from fast and furious price action.

Historical studies of forex market seasonality have shown that new months can often bring a shift in market conditions and potentially price trends themselves. If month-to-date price action is any indication of what to expect, the Dollar Index may continue to give back much of its January and February gains into final weeks of March. - DR