Fundamental Forecast for Dollar: Neutral
- A rebound in Treasury Yields and the Dollar reflect the market’s press against an ambitious FOMC forecast for rates
- Fed timing speculation will be one of the key themes that has potential fuel with Janet Yellen’s semi-annual testimony
- See our 1Q 2016 forecast for the US Dollar in our Trading Guides page
A number of major market themes were driven this past week; but for FX, the Dollar’s remarkable volatility grabbed most traders’ attention. Will the Greenback finally rekindle a full trend and pull the broader FX market it once again in the coming weeks? Taking measure of the currency’s performance this past week, the range of the past 10 months held firm with the 200-day moving average keeping the floor beneath the Dow Jones FXCM Dollar Index (ticker = USDollar). However, the technical restraints doesn’t fully account for the extraordinary volatility experienced. The sharpest two-day drop intraweek in two-and-a-half years, followed by a robust Friday rebound speaks to a market more capable of transitioning to a genuine trend.
Over the past year, the Dollar’s bullish ambitions have tangibly cooled. While this hasn’t seen the currency completely lose grip, it has certainly lost the remarkable momentum through 2014. This restraint is borne from the market’s doubt of the FOMC’s ambitious monetary policy forecast. Despite the central bank’s December rate hike, the market has maintained its boldfaced skepticism of the group’s projections for its pace of tightening this year. According to the forecasts from the policy authority at liftoff, 2016 will supposedly see 100 basis points (bps) of gradual hikes. That is four moves at a standard 25 bp clip. In clear contrast, the market through swaps and Fed Fund futures show serious doubt of even one hike. That disparity was clear through 2015, with each deferment by the Fed justifying the Dollar’s waylaid advance. As of today, the disparity between market and central banks is as large as we have seen in years.
As this extraordinarily fundamental discrepancy closes (conforming to the dovish market or hawkish Fed), the impact on the Dollar will be substantial. The influence this theme holds over the market was evidenced in last week’s volatility. The dramatic two-day drop through Thursday was spurred by the troubling employment, inflation and business details of the ISM service sector report. The subsequent rebound was just as clearly launched by the January employment report. While the headline NFPs may have fallen short of consensus, its average has been a hefty positive net increase of jobs month-in-and-month-out. Moreover, the unemployment rate has dropped to a multi-year low 4.9 percent and the inflation component in wage growth swelled. Further support of this clout can seriously swing the greenback’s next trend.
In the week ahead, there are a few items of moderate importance and one that is exceptional. Import inflation, retail sales, consumer confidence and a few Fed speeches will hit the radar. However, it is Fed Chairwoman Janet Yellen’s semi-annual report on monetary policy in Congress that will give us the most definitive read on the group’s views of monetary policy timing.
Since everything in the FX market is valued on a relative basis, it is important to keep in mind the context. Even if the Fed looks like it will have to delay its ambitious forecast (likely), it could still find the Dollar outpacing its major counterparts. For example, if the US central bank is still seen managing just one hike this year; it would be extraordinary contrast to fresh efforts by the ECB, BoJ and PBoC to upgrade their accommodative stances. And, these dovish counterparts taking further steps to halt growth, inflation and financial issues is likely. As such, keeping an eye on the Chinese foreign reserves figures, Japanese GDP (Monday after next) and ECB rhetoric will be just as important in assessing the Dollar’s bearings as the US data itself.