Fundamental Forecast for Dollar: Bearish
- The FOMC lowered its 2016 rate forecast from 100 to 50 bps, but that still confers considerable advanced to the Dollar
- Risk trends will carry heavier influence moving forward and counterparts will amplify USD faults and virtues
- See how retail FX traders are positioning in the Dollar-based majors heading into, and after the FOMC rate decision.
The Dollar has taken a nasty spill, but how do we reconcile the recent decline against years of rally and the proximity of a near-decade high? In the past three weeks, USDollar has dropped as much as three person – the most aggressive slide from the world’s most liquid currency since June of 2013. The past week’s tumble was especially pronounced given its fundamental leverage. Another significant downgrade in the Fed’s rate forecasts gave weight to speculative skeptics and traction in selling pressure to the tune of the sharpest two-day loss in over two years. Yet, is this the inception of a prolific bear trend or the limited evaporation of bullish excess? The influence of the market’s two most prominent themes (risk trends and relative monetary policy) and cross currency influence will decide.
There is little denying the momentum in recent selling pressure – following 10-months of flagging bullish conviction. And, recent fundamental developments seem to lend significance to the price move. This past week, the Federal Reserve held its benchmark range of 0.25 to 0.50 percent and pressed its concern over global stability. The reference is significant as it insinuates there are further hurdles to further hikes beyond the dual mandate of maximizing employment and stable inflation. The FOMC’s updated forecasts made that reticence certain. The already dubious projection for 100 basis points (bps) of hikes in 2016 – equivalent to four standard quarter percentage point increases – was downgraded to 50 bps of tightening through year’s end.
Such a significant fundamental downgrade for a currency that has climbed principally on its favorable monetary policy standing would naturally spur a retreat. Yet, the depth of the slide should be considered rationally. This is unlikely to prove a spark that burns with or without further oxygen to feed the short side’s momentum. Yet, when we consider the Greenback’s position even after the dovish downgrade; we are still dealing with a currency that is backed by speculation of higher yields into the future where most other policies involve active quantitative easing programs, rate cuts and even negative yield. So,while there may be some premium that needs to further burn off; we won’t likely see years of gains reversed before finding equilibrium.
Moving forward, the Dollar’s aura of a fundamentally-bulletproof currency has disappeared. That will make the Greenback more susceptible to subsequent changes in rate forecasts and to the temperament of the speculative crowd. According to the December Fed Funds futures contract, the market is still dubious of the central bank’s reduced forecasts for rates. The contract is pricing in a 90 percent probability of a single 25 bps hike. That still presents a serious discount to the official forecast and therefore room for speculative maneuvering. And, a persistence to back further rate hikes – any rate hikes - subverts the extreme skepticism born of the expected convergence of global monetary policy or a ‘Shanghai Accord’.
For data, the coming week is light for influence. Another round of Fed speakers will be on deck with the most influence for rate speculation. A National Activity Index from the Chicago Fed, durable goods orders and housing stats offer limited reach to the dual mandate. On the other hand, risk trends will represent a more capable grapple to Dollar volatility. The S&P 500 and other risk-oriented markets have extended a multi-week climb; but the fundamental backdrop to support the move is more than porous. Abrupt market moves are more likely to align to risk aversion; and the Greenback is likely to revert to a more responsive haven status. Risk or data moves this week however will be tempered somewhat by holiday trading conditions as March 25 is Good Friday for many markets.