- Debate over the timing of the Fed’s next rate hike was drowned out by China, commodities and capital markets’ plunge
- While risk aversion is broadening, the Dollar has yet to show it is serious about resuscitating its haven appeal
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The Dollar still carries the glow of last month’s Fed hike and there is a new – and traditionally favorable – wind blowing in the currency’s favor: risk aversion. Yet despite, the encouraging fundamental circumstances, the Greenback is showing little of the drive it had enjoyed the past few years. The equally-weighted USDollar Index has inched up to a 12-year high while the trade-weighted ICE Dollar Index is virtually unchanged. Drives for commodity-currency based majors (USDCAD, AUDUSD, NZDUSD) and the tumble in the Cable (GBPUSD) seem to have more to do with counterparts than the Dollar itself. EURUSD, the world’s most liquid currency pair, perhaps best reflects the situation with a minor anti-dollar close week-over-week.
If the fundamentals are favorable, why isn’t the currency performing? Price action is a consensus of the market’s views. What seems clear in an academic interpretation may find the masses place the emphasis on value somewhere else. We were already seeing the weight given to the Fed’s competitive monetary policy bearing fade through the closing months of 2015. After the first rate hike, that conviction further cooled. With considerable premium afforded the Dollar for the first rate hike and most scenarios of a dovish turn boding just as poorly for FOMC counterparts, the greatest potential is for the USD finding broader appeal for an accelerated rate path. Yet, that will be difficult to accomplish in current conditions – amid struggling capital markets and commodity deflated inflation expectations.
Rate speculation has a date to contemplate: January 27 when the FOMC next meets. Yet, the market places a low probability on a hike so soon after December’s launch. Nevertheless, the coming week’s docket will help shape the discussion of timing/pace. Chief rate fodder will be the US consumer inflation statistics (CPI) due Wednesday. Price pressures are the primary restraint to a more aggressive tightening pace, but the tepid inflation figures are effectively curbed by the deep dive in commodity prices. It is unlikely that we see the case for a hike this month develop from this data.
If relative returns are not going to be the primary motivation for Dollar movement in the week ahead, we should look at the other side of the coin – risk. The market is certainly far more interested in the bearings of speculative appetite at the moment than it is with which extremely low benchmark yield is set to barely nudge higher next. Sentiment suffered a nasty spill to close this past week. Global equities were trounced, high yield fixed income gapped down to mullti-year lows and the carry-focused Yen crosses started to take out the support of long-running bull trends. Fear of a global economic slowdown, China’s intervention drawing protectionist retaliation and simple crowding for the exit can easily revive and escalate this theme.
Risk aversion holds tremendous potential for the financial system’s current positioning and is a great untapped fount for the Dollar. That said, the Greenback needs a more extreme degree of risk aversion to tap that well. At moderate – or ‘transitional’ – levels of deleveraging, the USD itself may find itself on the chopping block as traders take off their long-Dollar-on–‘higher’-yields positions. When the question is liquidity though, there is no debate. As such, FX traders should keep close watch on cross-market correlation and volatility measures to gauge intensity. The stronger they are, the greater the demand for a no-fuss haven.