US Dollar’s Bid for 12-Year High Will Hinge on Fed’s Decision
Fundamental Forecast for Dollar:Neutral
- An active or expectd dovish shift from the ECB, PBoC and BoJ leverage the Dollar’s remarkably monetary policy bearing
- Depending on whether the Fed maintains course, abandons a 2015 hike view or pulls the trigger; the impact will be wide
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The Dollar posted its best week performance in five months with this past Friday’s close. The rally was derived less from the currency’s own fundamental improvement rather than slump amongst its major counterparts. As we frequently experience, the FX market is one of relative strength. If the entire field of currencies is sliding into a fundamentally adverse situation – in this case dovish – then all the outperformer needs to do is to hold its bearing. While the Greenback rose on the backs of its most liquid alternatives, that indirect leverage would struggle to keep momentum, especially with the 12-year highs in site. Yet, we may find the next move is decisive and made with US event risk as the Fed prepares to wade back into monetary policy. And, volatility does not have to fall in currency’s favor.
It is important to appreciate the market conditions we are dealing with when establishing the tempo and bias behind the market. The second half of this past week, an otherwise quiet trace of a fundamental and technical range turned into an outright rally for capital markets and the Dollar. Through a revival of speculative appetite – the S&P 500 is now within 3 percent of its record high set in May – the safe haven dollar still managed an incredible rally of its own. That was due in large part to the unexpected fuel provided by the ECB’s remarks on reviewing the need for more QE in December followed by the PBoC’s announcement of a rate cut. That is a stimulus punch from two major Greenback counterparts that would further leverage dovish expectations for other dovish leaning groups like the BoJ, RBA and SNB.
With volatility on the rise and the Dollar’s collective compeer in retreat, we enter the new trading period with a highly unpredictable and potentially dynamic backdrop. At the center of the clamor will be the Federal Open Market Committee’s (FOMC) policy decision on Wednesday. This is not the quarterly event with the updated forecasts, and it is not even the most contention policy gathering remaining in the year – that would be December’s meeting. However, the market is so on-edge and biased to this event’s outcome that the potential for a sizable impact is high. Looking at the market’s view, there is no hike fully expected until clear into the middle of 2016 – much less through the end of this year. Therefore, the anticipation runs along the lines of no change and rhetoric that naturally softens its tone on conviction for liftoff sometime this year, which was still expected by 13 of 17 members in the September forecasts.
If the Fed meets these expectations of a dovish tack, the impact will not likely be particularly dramatic. It is heavily expected and what’s more, its counterparts are taking steps to actually ease. In alternative scenarios, though, considerable volatility lurks. In the most dramatic outcome, a surprise rate hike would likely rally the Dollar; but it would also trigger a sharp reversal in risk trends through equities and the like. That would hypothetically leverage the fundamental appeal of the Greenback. Yet, amid such tumult, roles and expectations become fluid. In the more likely and less dramatic outcome, we could see rhetoric that suggests the group is still on pace to hike before year’s end. That too would be an unexpected outcome and could factor into divergent policy bearings as well as risk-positioning. That said, it would likely be a more staid and in that way consistent response.
Aside from the FOMC decision, the US docket has an array of indicators set for release. The top two listings are the 3Q GDP release due Thursday and PCE deflator on Friday. Growth for the world’s largest economy can equially dictate rate expectations and investor sentiment. The PCE is the central bank’s preferred inflation indicator. It’s impact will be dictated by how the Fed decision plays out. Outside its own docket, it will be important to further watch the listings of the United State’s largest counterparts. The BoJ rate decision, Eurozone inflation figures, UK GDP, Chinese plenum and RBNZ rate decision are high-profile event risks that can continue to work the indirect fundamental leverage for the Greenback. Be cautious this week.
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