US Dollar’s Bearish Spark Fails to Power Trend as Risk and Fed Balance
Fundamental Forecast for Dollar: Bullish
- Fed Funds futures are now pricing in the first hike out to July, which makes the Dollar’s slip seem small
- A light docket for data and Fed speakers will leverage the importance of the Chinese GDP and ECB rate decision
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The Dow Jones FXCM Dollar Index (ticker = USDollar) suffered a distinctive and bearish technical break of 2015’s carefully contained congestion this past week. Yet, the speculative bait wasn’t taken by the market. In fact, the currency index finished out the past week little changed. Given the unique balance the currency maintains between its standing as a safe haven and the likelihood that the Fed will lead the hawkish policy shift, there are bullish clauses for both extremes of the risk spectrum. We are unlikely to stretch to either limit of that spectrum in the week ahead, but that doesn’t preclude movement from the Dollar. Amid changing currents for market-wide sentiment trends and monetary policy intentions, the currency will find direction and volatility as a counterweight.
Among the many fundamental themes that drive the Dollar, the most pressing development has been the rapidly deflating Fed rate forecast. The market has long been skeptical of the FOMC’s own forecasts for a 2015 rate hike (in past months it was projected to be multiple hikes), so the recent slide in data and rise in concern for global headwinds wouldn’t translate into much in the near-term curve. Instead, their doubt has extended to question the entire hawkish ambitions of the central bank. Liftoff is not fully priced into Fed Fund futures until July. Further, the rolling 12-month forecast for rates has been cut in half from the beginning of August.
With the slide in rate forecasts, the primary fundamental leverage behind the Dollar’s multi-year climb has turned inert. And yet, despite the cooled forecasts, the currency has yet to lose much ground. Most of the Majors have turned to congestion rather than reverse. That is in large part due to the relative position of its fundamentals. As conditions for a nearby rate hike seem to withdraw, the same soft tone colors more dovish counterparts. Expectations for rate further rate cuts from the RBA and RBNZ rise while a desperate market pines for upgrades to ECB and BoJ stimulus programs. The scale may be moving substantially, but the relative positioning of those on it does not.
Should conditions improve and preclude the need for more accommodation, the Fed will find conditions once again supportive for a near-term hike. If they deteriorate so severely that the group would have to abandon their plans to normalize all together, it will likely come amid such severe risk aversion that the Dollar reverts to its ultimate haven status. At the extremes of global conditions, the Dollar stands to reap quick gains.
We are unlikely to hit such extremes in the coming week, but we should be prepared nonetheless given the fluid condition of the global economy and financial system. In the fundamental grey areas, the Dollar will be still be exposed to meaningful swings. On the risk front, the steady slide in volatility and slow climb of benchmarks like US equities will be put to the test. While the severe move of August is behind us and the cumulative fears of China, Emerging Markets and policy normalization have eased; there are likely restraints to speculators’ ambitions now. In past years, blind faith in monetary and a dearth of sharp market moves drove investors to take ever greater risk to earn a competitive return. That pain tolerance is much lower now. Should the climb from the S&P 500 stall, it will likely firm volatility levels and stoke the Dollar’s appeal.
On the docket, data will likely fall short of the market’s volatility sightline. The housing data, national activity figure from the Chicago Fed and manufacturing survey are far from top tier event risk. As for the round of Fed speeches, we have seen confusion and skepticism rise from the conflicting views from the various voters and non-voters. Far more capable should be some of the international events. Chinese 3Q GDP will be a great risk spark as one of the primary concerns for global investors. The ECB rate decision will also establish the opposing extreme of the monetary policy scale. Any whiff of a QE upgrade from Draghi, and EURUSD will leverage a broad Dollar move. -JK
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