Fundamental Forecast for Dollar: Neutral
- The next FOMC decision is scheduled for March 16; and there is a wide gulf between the market’s and Fed’s outlook
- Top event risk on the US docket are the January labor statistics and the Fed’s preferred inflation reading for December
- See our 1Q 2016 forecast for the US Dollar in our Trading Guides page.
The USDollar closed at a fresh 12-year high this past week. Yet, the occasion of breaching such exceptional heights has repeatedly disappointed over the past year. For the Greenback, ‘breakouts’ have chronically lacked follow through. This isn’t just a technical shortfall, rather it is a sign of the lackluster fundamental drive behind the market. Divergent rate expectations, rising market volatility and a shift to consumer economies have all benefit the benchmark currency. However, this is not an endless well of strength. To project the Dollar further on already extended moves like those seen with EURUSD, GBPUSD and AUDUSD; a tangible upgrade is needed. Will we find it on the coming week’s docket or headlines?
There is little debating it: the Dollar is one of the FX market’s most robust players. Yet, that doesn’t mean it will simply keep climbing through the foreseeable future. This is a relative market and equilibrium is eventually found when a currency trades at the appropriate premium or discount to its counterparts. With a modest yield advantage and elevated resting rate of volatility in the FX market, the Dollar seems to have found its balance. To make its next move, the currency’s fundamentals need to shift…or its counterparts can provide indirect leverage.
Weighing the fundamental themes that can effectively move the USD, the greatest potential still resides with general risk trends. The problem is that the currency isn’t finely tuned to small alterations in sentiment like Yen crosses or emerging market assets are. To tap the Greenback’s unusual risk standing, we either need to see robust speculative appetite that feeds rate expectations (its yield advantage) or steep enough risk aversion to divert capital to liquidity refuge. Reviving true investor optimism is unlikely given the premium many markets still trade at, the use of leverage, the dour outlook for global growth and discrete risks such as China’s stability. Sheer risk aversion on the other hand finds central banks waiting in the wings with liquidity lines and deeply engrained moral hazard. Neither side is unconquerable, but they are especially difficult to meet.
Far more palpable a driver in the week ahead is the changing tides of monetary policy. This past week, the Fed decided to hold rates steady after the December hike. They made mention of global growth and financial concerns, but nothing in the statement would backtrack on the consensus forecast offered at the end of 2015 calling for 100bps (4 standard) worth of hikes this year. That is sharply contrasting the market’s own 25bps forecast for the coming 12 months via swaps. Shifting probability either towards the central bank or market’s view is the work of capable event risk. This week’s PCE report (the central bank’s preferred inflation figure) and Friday’s labor statistics will draw close scrutiny. The wage growth figures will be more remarkable than the traditional payroll change or slow jobless rate update.
The other factor to consider for Dollar guidance is the strength or weakness of its major counterparts. A rebound in oil and other commodities this past week has lifted the Comm Bloc (CAD, AUD, NZD) as well as currencies for oil-producing Emerging Markets. China has taken steps to firm its own currency to stem the perception of disorderly capital outflows and should be monitored closely. With the Euro and Yen conspicuously steadying despite widening divergences in monetary policy to the Fed, market influence ascribed to yield gaps and stability should be considered. And, key event risk like the BoE decision can shake up competitive standings.