Fundamental Forecast for Dollar:Bearish
- A weak September NFPs has reinforced the market’s doubts of a near-term Fed ‘liftoff’
- Data will carry less influence over rate forecasts compared to Fed remarks and minutes ahead
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The Dollar was within reach of 12-year highs this past week; but when the opportunity was presented to revive the long-term bull climb, fundamentals falterd. There are two dominant themes for the FX market, and both favor the US currency: relative monetary policy and global investor sentiment. While the lean from each generally supports the Dollar, both have received significant discount by the market over the months. A more severe policy push would have to come from certainty of a rate hike before year’s end, while catering to the ‘haven’ status would require a committed and market-wide risk unwind. That level of escalation will be difficult to stoke. That said, it is likely only a matter of time before a more significant speculative deleverage and Fed rate hike are realized. As such, swoons from the Greenback will also be limited.
Had last week’s labor report printed differently, the Dollar may have forged the next leg of its rally or been primed to do so with the next catalyst. Instead, the September NFPs significantly lost traction in the fight to erode the doubt over the first Fed hike. In additional to the biggest headline payroll miss in six months, the participation rate further slipped to a 38-year low and wage growth stagnated at 2.2 percent growth. The market was already dubious of liftoff before the end of the year, but with the erosion of the underlying labor figure and inflation pressure solidified the skepticism and deflated some of the Dollar’s first-mover premium.
According to Fed Funds futures, the probability of an October rate hike dropped from 11% to 2%. A move by the final gathering of 2015 in December slid from 42% to 32%. Yet, skepticism of the central bank’s motivation is nothing new. The majority of the speeches given by Fed officials these past weeks have marked a clear effort to ‘warn’ market participants of the appropriateness of a near-term hike, stress its modest importance as a small move from the near zero bound and balance the conversation by noting the risks of maintaining emergency policy efforts for too long. That is a strategy that heavily implies a hike without pre-committing.
Even of the Fed officials intend to follow through with a hike this month or in December, it will be difficult to convince the market of that probability without actually pulling the trigger. The data on this week’s calendar doesn’t carry the kind of weight necessary to alter views. Trade, import inflation, consumer credit and service sector activity figures don’t cut close enough to the monetary policy mandates for full employment and steady inflation. That leaves shaping speculation to Fed communications. There are a number of FOMC’s rank scheduled to speak this week, but they are unlikely to be more clear in their bias than what we have seen the past few weeks. The minutes from September’s meeting may offer better insight into what many officials called a ‘close call’. That may prove the most capable driver through the week.
Meanwhile, the risk bent for the Dollar is a constant opportunity. However, last week offered a considerable buffer to levels where the tough choices will have to be made. The S&P 500 marked a meaningful rebound that puts it well off the year’s lows. For the Greenback, a modest retreat does not meet the exceptional drive necessary to reactivate the currency’s liquidity haven status. We haven’t seen this particular fundamental face for the Dollar appear in years. That said, this too is an inevitable reinforcement. A meaningful and lasting rebound in risk appetite is unlikely as the market’s recent bounce as founded in response to an expected extension of policy accommodation - not exactly the conditions that rally the value investors. If growth did start to take off, it would spur a normalization of policy and necessitate a repricing of leveraged risk taking. Risk ebalancing will eventually lift the Dollar, but it may take longer than bulls would hope for.