Fundamental Forecast for Dollar:Bullish
- Through trading at a 12-year high, the USDollar Index has struggled to make meaningful progress
- While uncertain risk trends remain ahead, a horde of event risk ahead is anchored by a FOMC decision and US GDP
- See our 1Q 2016 forecast for the US Dollar in our Trading Guides page.
Technically, the Greenback (USDollar specifically) has advanced for fourth consecutive weeks through Friday’s close. That’s an impressive run especially considering it is marking serial, 12-year high closes. That said, the run is virtually devoid of conviction – which is momentum from a price perspective. The lift the currency has found to its present lofty level was founded mainly through monetary policy, and the premium it afforded has been largely absorbed. Yet, that doesn’t necessarily mark the end of the bulls’ control. A divergent rate bearing will be revived with a range of rate decisions led by the Fed’s meeting. What’s more, the stronger the push of all those catalysts tracing back to risk trends; the closer the market comes to unleashing the Dollar’s haven appeal.
As has been the case throughout January, this past week’s primary focus was the ebb and flow of global risk appetite. A rebound for equities, Yen crosses and other sentiment-benchmarked assets through the second half of the week allowed investors catch their breath. There seems limited catharsis in this correction though as the level of volatility in the markets keeps both short-term tactical traders and long-term buy-and-hold investors on the sidelines.
The Dollar is a well-known haven – one of its defining traits. Yet, it hasn’t exploited that status in 2016’s broad market slide. The safety standing remains, but its sensitivity has been warped by the same driver that afforded its gains over the previous years. The anticipation – and later realization – of Fed hikes led speculators to crowd in ahead of higher, competitive yields moving forward. That also, however, made the USD a carry currency. It wasn’t for the actual carry itself, but frontrunning the flood of capital that comes with interest rate changes. That is an important caveat as we are unlikely to the same degree of carry unwind as say with the AUD, NZD or high-yield emerging market currencies. Yet, that is also a buffer to its safety appeal.
In a market looking to unwind return-centric exposure (‘risk aversion’), there is first a need to sell the risky exposure and then there is a transfer of capital to a haven. The Dollar is experiencing both pressures. If the intensity builds though, the limitations of yield chasing in US markets will readily be overwhelmed by a need for liquidity that will seek out the Dollar on the way to US Treasuries, money and cash markets. Intensity of risk aversion therefore matters. There is plenty on the docket that can try its hand at jump starting the volatility wave machine again this week – US 4Q GDP, a slew of rate decisions, important US corporate earnings releases – but it is the unscheduled that poses the greatest threat and highest potential. China resorting to protectionist measures to arrest its economic woes, emerging markets showing trouble after bleeding too much foreign funds or just the ‘animal spirits’ taking over are concerns to monitor.
While we should keep a close eye on how the scales of sentiment tip ahead, there is also a good probability that the Dollar is stirred by a revived interest in monetary policy. The currency has certainly priced in the first-mover status for its December rate hike, but that isn’t the end of it. The pace of subsequent tightening that further contrasts global counterparts is ripe for establishing relative value for the Greenback. The FOMC forecast 100 basis points of further hikes in 2016, but the market is skeptical of just 50 basis points. While a hike is unlikely at this meeting (even Fed officials have stated that plainly), their statement will give good guidance to forecasts. What’s more, they will let us know how much weight they give to the painful tumble in capital markets (remember their ‘wealth effect’ objective?) to start the year.