Fundamental Forecast for Dollar:Neutral
- September NFPs will be the headline grabber for the week, but there is also key inflation data and 9 Fed speeches
- A rumbling in risk trends is a constant threat to test the Dollar for rate advantage versus haven appeal
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The US Dollar posted an impressive advance this past week, but it conspicuously fell short of breaking the 12-year high on the Index and clearing key range boundaries with major counterparts. With many investors having anticipated a quiet period following the Fed’s hold and a few of the major themes falling just short of full-blown conviction, we fell just short of comprehensive Greenback and ‘risk’ moves. However, with key market fears focusing attention, Fall trading conditions filling out and a dense economic docket ahead; the motivation for a decisive break and further trend development may materialize in the week ahead. For the Dollar, the scenarios are biased towards the bulls; but mounting the conviction necessary to forge the next leg of a major move will be no easy feat.
Given the orientation of event risk on the forthcoming docket, it is reasonable to expect the Dollar to ride rate speculation. Over the past year, relative monetary policy has proven the most pervasive market driver for both FX and capital markets. For the Dollar, this has manifest itself in one of the most impressive advances across the board – whether compared to core, emerging market and even high-yield currencies. The belief that the Federal Reserve will be the first major central bank to lift rates has generated a speculative advantage that overrides interest for currencies that currently enjoy higher rates. Global rates of return are so thin, that traditional carry is trumped by the effort to position ahead of major capital shifts. And, a leading rate hike from the world’s largest central bank will certainly channel a considerable amount of volume.
For the Dollar, rate speculation has hit something of a plateau. While the market continues to run at a discount to the central bank’s own forecasts, the currency itself has already posted considerable gains on the basis of its first-mover status. To further its run, we need to see either doubt of a 2015 hike completely evaporate or upgrade the expected pace of Fed tightening – in other words accelerate the timing of subsequent hikes after they begin. Currently, Fed Funds futures is pricing in a 34 percent probability of a hike before the end of the year. Through 2016, the hedge to rate changes fully account for only two tradigional 25bp increases.
To help jump start rate speculation in the week ahead, we have a remarkably direct listing of event risk to analyze. The media favorite will be Friday’s September NFPs. Though the FOMC keeps pushing back their measure of ‘full employment’, we have essentially met the criteria for a hike. Inflation remains the obvious disconnect in their dual mandate. The wage component of the labor report will help shape this conversation, but Monday’s PCE deflator will be the more direct shot to rate speculation. That series is the Fed’s favored inflation measure.
Data is easier to read as ‘objective’ for rate speculators, but it will be difficult to ignore the laundry list of Fed speeches scheduled throughout the week. There are nine officially penciled in. Between Chair Janet Yellen, Vice Chair Fischer, dove Evans and hawk Bullard; we are running the gamut of policy influence and stance. This past week, the range of speakers offered up a surpringly consistent voice for tightening before the market’s presumed timetable. If that carries through going forward, it will be difficult to ignore the concerted effort to shape expectations through communication.
While it will be easier to keep tabs on the progress of monetary policy speculation, the greatest potential for Dollar movement resides with sentiment trends. The Dollar is a haven when risk aversion devolves into a need for liquidity. We have only seen a glimpse of that level of fear in the capital during mid-August’s fireworks. Yet, the Greenback also generates more heat from FX-centric volatility as well. With Emerging Market exchange rates building momentum and various risk-leading benchmarks (like high-yield fixed income and biotech equities) threatening a more systemic slide in sentiment, the risk of a blow up is significant.