FUNDAMENTAL FORECAST FOR THE US DOLLAR: BULLISH

  • US Dollar finds fresh support as G7 summit stokes trade war jitters
  • Haven-bound capital flows to keep USD supported if tensions persist
  • G7 breakthrough would reinforce hawkish FOMC policy projections

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The US Dollar remained on the defensive for much of last week as markets continued to revel in the de-escalation of Eurozone political risk. Haven-seeking capital flows that launched the currency to an 11-month high as governments in Rome and Madrid appeared ready to implode reversed course after both managed to muddle through (at least for now).

A lifeline emerged amid trade war concerns, as expected. Investors turned defensive ahead of what promises to be a contentious G7 leaders’ summit in Quebec. The gathering will mark a showdown between US President Donald Trump and his counterparts after he opted to let lapse steel and aluminum tariff exemptions for the European Union and Canada.

The summit’s outcome will be revealed on Saturday, setting the tone for markets when the opening bell rings on Asia Pacific bourses Monday morning. Signs of a deepening rift and likely escalation of hostilities between the world’s top economies is likely to translate into another risk-off push, boosting the greenback. A last-minute breakthrough will probably have the opposite effect, though probably not for long.

Indeed, the defusing of trade tensions might be reframed in more supportive terms for the benchmark currency as the FOMC monetary policy announcement enters the spotlight. A rate hike is widely expected. That puts the accompanying statement, official forecast update and post-meeting press conference with Chair Jerome Powell into focus.

Projections for next year’s rate hike path ought to be particularly interesting. Indeed, central bank officials and market participants seem broadly aligned on the outlook for 2018, with one more hike due after this month’s increase. That shifts speculation forward, where the priced-in policy trajectory still trails FOMC members’ more optimistic view.

A broadly hawkish tone echoing increased confidence in reflation prospects that showed up in the statement following May’s FOMC conclave is likely to sound more plausible if trade war worries are diminished, clearing an important obstacle to further tightening. It may be somewhat tarnished if tensions persist, although the reach for liquidity in such a scenario may keep the US unit well-supported all the same.

FX TRADING RESOURCES

--- Written by Ilya Spivak, Sr. Currency Strategist for DailyFX.com

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