Fundamental Forecast for the US Dollar: Neutral
- The US Dollar has been dragged lower by skyrocketing Fed rate cut odds: markets are now pricing in a 96% chance of one 25-bps rate cut in 2019 and an 86% chance of two rate cuts this year.
- US economic data momentum has weakened in recent weeks, and neither of the two ‘high’ rated US economic data release this week – the May US inflation report and the May US retail sales report – look to be the saving grace for the US Dollar.
- The IG Client Sentiment Indexshows that retail traders are buying the US Dollar during its declines.
US Dollar Rates Week in Review
The start of June has not been good for the US Dollar. Declining against each of the other seven major currencies, the US Dollar (via the DXY Index) posted significant enough losses that it now appears the prospect of major topping potential is starting to play out. The dramatically weaker US Dollar has played a larger role in the recent gold price rally.
Led by a surge in Federal Reserve rate cut odds, the commodity currencies were among the top performers over the past week, with NZDUSD gaining 2.05%, USDCAD losing -1.88%, and AUDUSD adding 0.91%. Meanwhile, with the European Central Bank failing to meet markets’ expectations for a more significant dovish policy shift at the June ECB meeting, the Euro rallied sharply at the end of the week, resulting in EURUSD trading higher by 1.48%.
After Fed Chair Powell Commentary, 2019 Rate Cut Odds Surge
In a speech last Tuesday, Fed Chair Jerome Powell said that policymakers are now “closely monitoring” the impact of trade developments.Fed Chair Powell has also said that the Fed will “act as appropriate” to help sustain the expansion – an expansion dating back to the recovery from the Great Recession/Global Financial Crisis that is about to reach an all-time record next month.
With the imposition of the China tariffs at the start of June, the US-China trade war is about to intensify its already negative impact on the US economy. In turn, US President Donald Trump may get his wish for more accommodative monetary policy.
Federal Reserve Rate Expectations (June 7, 2019) (Table 1)
Recall that at their peak following the March Fed meeting, rates markets were pricing in a 58% chance of a 25-bps rate cut in September; now, odds of a September cut are 96%. In sum, there is an 86% chance of two 25-bps rate cuts by the end of 2019.
Most of this dovish shift occurred over the last two weeks of May and the first week of June. For example, at the start of May, Eurodollar contract spreads, which measure the difference in interest rate contracts between commercial banks, were pricing in one 25-bps rate cut by June 2020; as of June 7, they are pricing in three 25-bps rate cuts by June 2020.
No Fed Speeches Over the Coming Week Ahead of June FOMC Meeting
Unfortunately for traders who were able to take advantage of the volatility spurred on by Fed Chair Powell’s commentary last week, he will not be taking the microphone at any point anywhere over the coming days. Nor will any Fed officials; we’re officially in the ‘quiet period’ in the runup to the June Fed meeting.
Putting Fed officials’ recent commentary in context: it’s been rather dovish, producing a weaker US Dollar, lower US yields, and a rally in US equities. Without the catalyst of dovish Fed officials, these recent market moves may take a breather ahead of the June Fed meeting.
May US Inflation Report Due Wednesday; Inflation Expectations Have Tumbled
In the week ahead of the June FOMC meeting, there are two US data releases that traders should pay attention to in the wake of the much weaker than anticipated May US jobs report. On Wednesday, the May US Consumer Price Index is due to show a small drop in price pressures, not much of a surprise given the drop in US inflation expectations alongside oil prices over the past few weeks.
Crude oil prices fell by -12.4% between May 10 and June 7, down from 61.66 to 53.99. In turn, medium-term US inflation expectations, as measured by the 5y5y inflation swap forwards, have dropped by -23.4-bps from 2.299% to 2.065% over the same period.
US Inflation Expectations Have Dropped Alongside Crude Oil Prices (Chart 1)
According to a Bloomberg News survey, US CPI is expected in at 1.9% from 2.0%, and core CPI is due on holdat 2.1% (y/y). The headline monthly reading may prove more sensitive to the recent downturn in inflation expectations and oil prices: 0.1% is expected from 0.3% (m/m).
Even though the readings are around the Federal Reserve’s medium-term target of 2%, that US inflation expectations have tumbled will likely raise concern among policymakers at the June Fed meeting and underscore the dovish policy shift.
May US Retail Sales Due on Friday; Q2’19 US GDP Expectations Remain Soft
Consumption is the most important part of the US economy, generating nearly 70% of the headline GDP figure. The best monthly insight we have into consumption trends in the US might arguably be the advance retail sales report. In May, according to a Bloomberg News survey, consumption jumped with the headline advance retail sales due in at 0.7% from 0.2% (m/m).
Similarly, the retail sales control group, the input used to calculate GDP, is due in at 0.4% from 0.0% (m/m). Growth expectations may only be mildly supported coming out of the data, as Q2’19 US GDP is tracking well-below the Q1’19 US GDP growth rate of 3.2% (annualized).
Atlanta Fed GDPNow Q2’19 Growth Estimate (Chart 2)
Based on the data received thus far about Q2’19, the Atlanta Fed GDPNow forecast is looking for growth at 1.4%. The next update to the Q4’18 forecast will be released after Friday’s May US retail sales report. Overall, US economic data momentum has been on a downward path over the past several months, with the Citi Economic Surprise Index for the US down to -56.4 on June 7 from -42.2 on March 8.
Mexico Tariffs Canceled Prior to Implementation
In last week’s edition of the weekly gold price forecast, we opined that “regardless of the efficacy of using tariffs as a tool to negotiate on immigration, the fact is that the Trump administration has shown a willingness to go to places that other US presidential administrations have not.” So, is the eleventh-hour news that Mexico and the US have agreed to changes in the border policy – enough changes that US President Trump declared the Mexico tariffs “suspended indefinitely” – exculpatory proof that the Trump administration’s strategy of dealing with trade partners is indeed the right strategy to pursue?
Irrespective of how you may feel, the reality is that the Trump administration will likely see the Mexico border agreement as proof that the “tariff man” approach has been vindicated; an omen that the US-China trade war is unlikely to be resolved by the US caving in anytime soon.
No End in Sight for US-China Trade War
It bears repeating that traders will want to keep on eye on USDCNH prices as a litmus test in the near-future: China has used devaluation as a tool to ward off the effects of the tariffs, so Chinese Yuan strength (USDCNH weakness) may be interpreted as a sign that the trade talks are nearing a positive resolution; Chinese Yuan weakness (USDCNH strength) may be interpreted as a sign that the trade talks are nearing a negative resolution. After all, the 7.00 barrier of resistance in USDCNH prices may be the most important level for currency markets.
US Dollar Net-Long Futures Positioning has Started to Fall (Chart 3)
Finally, looking at positioning, according to the CFTC’s COT for the week ended June 4, speculators decreased their net-long US Dollar positions to 26.2K contracts, down from the 27.1K net-long contracts held in the week prior. Net-long US Dollar positioning has come down meaningfully from the start of the year: traders held 32.4K net-long contracts on January 1. There is likely to be another fall in net-longs during the next update will encompass the US Dollar price drop after the May US jobs report.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
To contact Christopher, email him at firstname.lastname@example.org