Fundamental Forecast for Dollar:Bullish
- The specter of a downturn in risk trends grows increasingly corporeal – and the dollar stands ready to take off if it does
- Meanwhile, rate forecasts will be revived this week between economic health updates (1Q GDP and NFPs) and the FOMC
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FX and capital market traders are anxious for activity. Stability is one thing, but the quiet that currently hangs over the markets carries the hallmarks of extraordinary complacency and an inevitable reversal to the opposite extreme. Given the markets lean and positioning over the years, the more charged scenario would be one where risk aversion and deleveraging unfold. That would be a boon for the greenback as its safe haven status is revived under the stress. But even if we are kept to wait for the return to risk engagement, there will be plenty of the US economic docket to keep the dollar occupied – including a FOMC decision, 1Q GDP release and April NFPs.
Always starting with the fundamental theme with the greatest overall potential over the market, risk trends are the first consideration for trading starting the next week. Already tepid, activity levels this past week fully collapsed with the holiday liquidity drain and never recovered. Now, among mature capital market trends and extremely low volatility and participation levels, we are finding measures so excessive that complacency is no longer an option. Perhaps the starkest measure is that of FX-based volatility. While the equity-based VIX is steady since the start of the month, its currency-sourced counterpart dropped another 20 percent (to 5.73 percent) to a seven year low – and only marginally off a record. Realized – also termed ‘actual’ – volatility is itself at a multi-decade low.
The wait for a rebound in risk trends has been a frustrating one. Bullish or bearish, sentiment can engage the market and offer meaningful trend – rather than the stunted chop we have dealt with. Looking back, there have been a few notable attempts to revive the optimism run, but circumstances of participation, leverage and exposure have consistently seen the move die. This tells us that to engage a lasting market-wide, sentiment-based move; it may have to be a deleveraging of risky exposure.
In the annals of history, the greatest extremes are typically the first to reverse. If that is the case with risk trends, the circumstances for FX activity measures may prove the spark for a more systemic change in attitude. A currency market-based increase in activity would likely favor the dollar – as volatility is associated to concerns of safety – but the most reliable driver for the benchmark would be a risk aversion move that spanned asset classes and investor type. The US docket this week is particularly well suited to get the ball moving.
Under normal circumstances, the expectation of a major release or event that can materially change investment conditions often encourages the trading ranks to sit on their hands. The schedule this week is spread out, but the market is unlikely to hesitate should Wednesday’s releases hit the right key. After earlier releases of US housing data and sentiment survey, the top listings come Wednesday with the release of the release of the first quarter growth (1Q GDP) report at 12:30 GMT and FOMC rate decision at 18:00 GMT.
For fundamental impact, these two indicators offer a clear view of the economic health of the world’s largest economy and the monetary policy assistance it is receiving. Even if they fall short on stirring the broader ‘risk on risk off’ mentality, they will still prove weighty measures for interest rate expectations – the other dominant theme for the dollar. This past week, medium-term Treasury yields have regained lost ground as rate expectations stabilized (though there is also a consideration that Treasuries will rise – and yields fall – as safety demand induces a bid). As we move closer and closer to the first rate hike, its time frame – whether further or nearer – should become clearer. As we see the timing take shape, traders will be more willing to better place the greenback in the ranks of rate forecasts with its major counterparts. – JK