Dollar Survives Reversal, Can Rate Speculation Hold Back Gravity?
Fundamental Forecast for Dollar:Neutral
- The unemployment rate update may not have impressed, but the jump in wage growth revived rate expectations
- Yields and counterparty risk have revived the Dollar, but is it enough to keep pace on its incredible rally?
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The Dollar came dangerously close to starting a speculative landslide this past week. Yet, once again fundamentals have stepped in keep the record-breaking seven-month bull trend intact. While the bull trend stands heading into the second week of February, there is relatively little conviction to launch forward with Monday. This past week’s NFPs have revived Fed rate expectations and deteriorating conditions in the Eurozone leverage a liquidity appeal for the Greenback. However, the policy contrast has likely reached its near-term limit and an anti-Euro haven may not provide the necessary degree of motivation to keep this pace.
Had it not been for the favorable outcome from the January employment figures this past week, the US Dollar may have very well dove into a correction. The headline data looked mixed – the net payrolls beat expectations by a modest 29,000 jobs while the unemployment rate unexpectedly ticked higher to 5.7 percent. Neither of these developments significantly alters the trend of improvement lauded by the Fed officials. The real surprise was in the underlying figures that the FOMC considered more ‘qualitative’. The participantion rate picked up from a near four-decade low, but it was the the 0.5 percent jump in wages (the biggest in seven years) and 2.2 percent pace that jump started the flagging rate speculation.
What the wage data represents is the potential genesis for inflation – the missing ingredient for hawkish conviction at the Fed. After the data was processed by the market, 2-year Treasury yields surged 24 percent (to 0.6435 percent) – the biggest move since December 7, 2010. Following suit, Fed Funds futures pricing the rate forecast through December added another 11 bps of expected tightening and the probability of a July hike rose to 52 percent. As we move closer the mid-year policy meetings (June 17 and July 29), speculation will intensify as data paths become clearer and time runs short. However, we are still four months out, and this week’s docket is light for data that is capable policy fodder. So while, the Dollar can maintain its advantage well enough; it will struggle to press it.
The burden facing the Dollar is largely a speculative one. Looking to speculative futures positioning in the COT report, we find this segment of the market is already long in record numbers (over half a million contracts). One-sided bets are prone to corrections from profit taking to de-levering. What’s more, the same strength that the currency has enjoyed for its favorable yield forecast can also turn it into a risk prone currency in the event of a broader risk aversion effort. Short-term FX positions looking to ride the yield disparity would be as motivated to unwind as those that were long traditional carry or equities. And, while the Dollar would eventually regain its footing should selling turn to pure liquidation; there is a large gap between speculative shakeout and liquidity scrambling.
Perhaps the Dollar’s most promising fundamental backer heading into the new trading week is a worsening of global confiditions that can hasten the demand for liquidity. This is especially true of the Euro where Greece’s debt standoff has found the country with one less important liquidity line and an accelerated time line issued by an unaccommodating European community. Another possible source of strength for the reserve currency is further fallout from global stimulus. We’ve already seen Switzerland’s central bank falter under the ECB’s efforts, and many others were already struggling before that. Cracks in the façade of complacency can quickly expose more systemic issues – such as asset bubbles.
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