US Dollar Forecast: What Bond Vigilantes? Setups for DXY Index, USD/JPY
US Dollar Outlook:
- The US Dollar (via the DXY Index) has dropped after the March Fed meeting alongside US Treasury yields. The dynamic of the greenback following US yields seems poised to continue.
- Overall, Fed Chair Jerome Powell remained resolute in the FOMC’s commitment to its low rate, extraordinarily loose monetary policy.
- The IG Client Sentiment Index suggests that USD/JPY has a bullish bias.
US Dollar Shrugs as Yields Deflate
At his post-meeting press conference, Fed Chair Jerome Powell shrugged aside concerns about higher inflation and rate hikes arriving faster than anticipated. With the 2023 median dot unchanged, the FOMC remains resolute in its commitment to its policy path, not dissimilar from when Fed Chair Powell went to Capitol Hill a few weeks back.
Even as US inflation rates continue to rise, Fed Chair Powell and the FOMC have taken the view that any uptick is “transitory” and will eventually subside. Their ‘confidence’ in this prediction is backed by history; just ask the Bank of Japan or European Central Bank about how successful they’ve been in achieving their policy mandates over the past decade-plus. Fed Chair Powell has taken that narrative away from the market in the short-term, provoking a pullback in US Treasury yields – and thus, the US Dollar.
Federal Reserve Interest Rate Expectations (March 17, 2021) (Table 1)
Following weeks of Fed officials downplaying inflation fears and suggesting that rising US Treasury yields reflect economic optimism, the March Fed meeting was another resolute step in that direction. Interest rate expectations remain firmly anchored as a result: Fed funds futures are pricing in a 93% chance of no change in Fed rates through January 2022.
Fed Chair Powell and the FOMC have been crystal clear: don’t expect the Fed to do anything along the interest rate channel anytime soon. If anything, an update on the SLR requirement (which we discussed ahead of the Fed meeting, here) should be anticipated in the coming days.
US Treasury Yield Curve (1-year to 30-years) (March 2011 to March 2021) (Chart 1)
We’ve previously discussed how “yields are wagging the dog.” Between Fed Chair Powell’s press conference and the upgrades to the Summary of Economic Projections, the stage was set for US Treasury yields to continue along their current rampage.
And while bond markets retain primacy, the reaction to the March Fed meeting suggests that bond vigilantes are not in control, however. If they were, US yields wouldn’t have given up their gains on the day, with the long-end coming back in significantly by day’s end.
DXY PRICE INDEX TECHNICAL ANALYSIS: DAILY CHART (March 2020 to March 2021) (CHART 2)
The DXY Index’s drop from a familiar zone over the past nine-months suggests that more pain may be ahead: the band going back to late-July 2020 has rejected the recent rally, and now the DXY Index is back below both 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.
While a bearish daily key reversal was avoid (thanks to today’s high failing to overcome yesterday’s high), a bearish daily piercing candle was established, and from a certain point of view, one might argue that the prior three days of price action have turned into an evening star candle cluster of sorts.
To little surprise, momentum is turning more bearish after the aforementioned candles. The DXY Index is below its daily 5-, 8-, and 13-EMAs, but still above its daily 21-EMA; the envelope is in neither bearish nor bullish sequential order. Daily MACD continues to narrow while above its signal line, while daily Slow Stochastics have already dropped out of overbought territory. A drop below the daily 21-EMA – which proved support in early-March – would be a sign that the DXY Index’s losses may soon accelerate.
USD/JPY RATE TECHNICAL ANALYSIS: DAILY CHART (March 2020 to March 2021) (CHART 3)
There are few better poster children for interest rate sensitive pairs in the FX world than anything tethered to the Japanese Yen, given the fact that the BOJ has instituted a strict form of quantitative and qualitative easing (QQE) with yield curve control (YCC); as US Treasury yields move USD/JPY typically follows, which is why this pair is in focus after a pivotal Fed meeting.
After showing extreme separation from its daily 5-EMA for several sessions spanning February and March, USD/JPY rates have returned to the shortest-term moving average, with a daily bearish key reversal forming. Daily MACD has nearly issued a bearish crossover while above its signal line, while daily Slow Stochastics are starting to edge lower within overbought territory.
USD/JPY rates appear to be losing steam, and if US Treasury yields are about to endure a period of relative softness, then the pair is susceptible for a deeper pullback over the coming sessions.
IG Client Sentiment Index: USD/JPY RATE Forecast (March 17, 2021) (Chart 4)
USD/JPY: Retail trader data shows 37.47% 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 6.18% higher than yesterday and 16.32% higher from last week, while the number of traders net-short is 4.58% higher than yesterday and 7.19% 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.
Yet traders are less net-short than yesterday and compared with last week. Recent changes in sentiment warn that the current USD/JPY price trend may soon reverse lower despite the fact traders remain net-short.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.