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US Dollar Wobbles But Fed Speculation and Liquidity Keep a Bid

US Dollar Wobbles But Fed Speculation and Liquidity Keep a Bid

John Kicklighter, Chief Strategist
US Dollar Wobbles But Fed Speculation and Liquidity Keep a BidUS Dollar Wobbles But Fed Speculation and Liquidity Keep a Bid

Fundamental Forecast for Dollar: Bullish

  • The probability of a December 16 FOMC rate hike according to Fed Funds futures Friday is 74 percent
  • Monetary policy is a steady fundamental current, but the true engine for the Dollar may prove liquidity and volatility
  • See how retail traders are positioning in the majors in your charts using the FXCM SSI snapshot

The US Dollar this past week thwarted what could have been a nasty reversal that changed the balance of sentiment. Having already stretched to 12-year highs, a number of surveys mark long-Dollar as one of the most oversaturated trades in the market. Yet, the market is there for a reason…for good reason. Whether we are looking forward to steady markets where the glint of yield attracts investors or liquidity-levered volatility that sends a current of fear through the system, the Greenback will be a favored vehicle for investors. The key variable is one of intensity, and that will be put to the test with the holiday trading conditions.

On Thursday, the United States will celebrate the Thanksgiving holiday. While this is specifically a market holiday for the US, the anticipated drain historically bleeds liquidity and dulls volatility globally. This will present a serious change in timbre for the currency and markets, but that doesn’t mean we can just shut down and expect our exposure to be safe through the four-day downtime.

From a speculator’s position, rate speculation is an international driver and it is building in intensity despite our heading into a traditionally ‘quiet’ period of the year. In the past three to four weeks, we have seen rate speculation around the Fed – and the contrast it draws to its peers – show more intensity than we have seen in months. According to Fed Fund futures traded on the CME, the market is pricing in a 74 percent probability that the central bank will lift rates on next month. Meanwhile, speculation of a QE upgrade from the ECB has seen similar confidence while traders waffle on the chance of a second BoJ stimulus upgrade.

For the just the coming week, there are a number of Fed speakers and top tier economic indicators (like the PMI figures and consumer confidence survey), but the most incisive update will be the PCE deflator for October. That is the Fed’s preferred inflation figure and it offers one of the last definitive readings on a key policy metric before the group deliberates at its final meeting this year. The November NFPs number due the first Friday of December will carry similar wait for the same reason. After the uptick in CPI (given perhaps too much coverage) and the multi-year high in wage growth in the last labor report (given too little), the PCE will not be taken lightly.

This coming week’s activity dip may pose the greater disservice for accelerating the sense of complacency that is commonly associated with the year-end period. Drained of liquidity by various holidays, the normal expectation is for quiet and steady gains (often called the ‘Santa Claus’ rally). However, this time around, the thin market conditions can lead to serious trouble as the threat of volatility remains dangerously high.

A number of big-picture financial risks hang over the markets including China’s economic cooling and financial stability; emerging market capital flows; and global growth trends among others. These threats lurk just in the background and can be set off by a range of sparks. Yet, there is one catalyst that carries with it a specific date and time: the December Fed decision. Not only can this cater to the Dollar’s relative appeal as a key FX pricing metric, but it can prove a trigger for some of the other threats. If we see a serious jolt moving forward, the combination of seasonal and systemic depressions in market depth can turn a bout of volatility into a financial shock. In that case, a Dollar driver can prove the source of a much more comprehensive demand for the currency.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.