US Dollar Forecast: Yields Wag the Dog - Levels for DXY Index, USD/JPY
US Dollar Outlook:
- The US Dollar (via the DXY Index) has rallied alongside US Treasury yields. That dynamic seems poised to continue as the narrative around the ‘reflation trade’ gathers pace.
- 1Q’21 US GDP expectations have moderated in the past few weeks, but remain incredibly robust by historical standards.
- The IG Client Sentiment Index suggests that USD/JPY has a bullish bias.
US Dollar Tethered to Yields
The expression “the tail that wags the dog” is deployed to describe a situation when one small factor becomes the dominant differentiator in outcomes. Although bond yields are but one aspect of global financial markets, they are in the driver’s seat. Yields are wagging the dog; commodities, FX, stocks, and seemingly everything in between are responding directly to movements in US Treasury yields.
For the US Dollar (via the DXY Index), this has been a convenient narrative as the ‘reflation trade’ gathers pace, where the greenback rallies alongside higher US yields and even higher US stocks. The reflation trade may continue to gather pace in the coming periods as the Biden stimulus package is signed into law, enhancing a macro environment defined by incredible government spending and low interest rates.
Federal Reserve Interest Rate Expectations (March 10, 2021) (Table 1)
Accordingly, after a week of Fed officials downplaying inflation fears and suggesting that rising US Treasury yields reflect economic optimism, interest rate expectations remain firmly anchored: Fed funds futures are pricing in a 93% chance of no change in Fed rates through January 2022. The bottom line: don’t expect the Fed to do anything along the interest rate channel anytime soon.
Atlanta Fed GDPNow 1Q’21 Growth Estimate (March 10, 2021) (Chart 1)
Based on the data received thus far about 1Q’21, the Atlanta Fed GDPNow forecast is looking for growth at +8.4% annualized. The estimate has moderated in the past few weeks from +9.5%, after rising sharply from +4.5% in early-February. The next 1Q’21 Atlanta Fed GDPNow forecast will be released on Tuesday, March 16 after the February US retail sales report (which spurred the last jump in 1Q’21 US growth expectations).
DXY PRICE INDEX TECHNICAL ANALYSIS: DAILY CHART (March 2020 to March 2021) (CHART 2)
In the prior US Dollar forecast update, it was noted that “a move over the mid-February swing high of 91.06 would suggest that the turn higher is gaining legitimacy.” The DXY Index has returned to a familiar zone that has served as both support and resistance going back to late-July 2020, as well as the 23.6% Fibonacci retracement of the 2018 low/2020 high range and the 38.2% Fibonacci retracement of the 2011 low/2020 high range at 91.93.
Momentum is turning after the recent rally. The DXY Index is below its daily 5-EMA, but above its daily 8-, 13-, and 21-EMA envelope, which is otherwise still in bullish sequential order. Daily Slow Stochastics are turning lower from overbought territory, while daily MACD is starting to turn lower albeit above its signal line. Now back below the initial intrayearly uptrend, DXY Index may be in for more choppy trading in the near-term.
USD/JPY RATE TECHNICAL ANALYSIS: DAILY CHART (March 2020 to March 2021) (CHART 3)
In the prior USD/JPY forecast update, it was noted that “rising US yields may stem a significant drop in the pair, particularly as USD/JPY approaches the rising trendline from the intrayearly swing lows. The recent advance in USD/JPY was rejected at the underside of the rising trendline from the March and September 2020 lows, itself a magnet for price action throughout November and early-December 2020.” This comment coincided with the late-February low in USD/JPY, which was promptly elevated by the surge in US Treasury yields to their highest level since February 2020.
The rally may have gotten a bit long in the tooth this week, given the separation between the spot price at close on Monday and the daily 5-EMA. To this end, even after two days of pullback, USD/JPY rates remain above their daily 5-, 8-, 13-, and 21-EMA envelope, which remains in bullish sequential order. Daily Slow Stochastics are trending lower but haven’t departed overbought territory, while daily MACD remains at its 52-week high (despite some weakness). More gains may be ahead soon for USD/JPY rates after some profit taking.
IG Client Sentiment Index: USD/JPY RATE Forecast (March 10, 2021) (Chart 4)
USD/JPY: Retail trader data shows 37.46% of traders are net-long with the ratio of traders short to long at 1.67 to 1. The number of traders net-long is 8.43% lower than yesterday and 23.33% lower from last week, while the number of traders net-short is 1.26% lower than yesterday and 15.34% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests USD/JPY prices may continue to rise.
Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger USD/JPY-bullish contrarian trading bias.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.