Dollar Volatility Risk Higher on Stronger vs. Weaker US Jobs Data
- Markets clinging to dovish view reflects wishful thinking
- Skew in policy bets creates asymmetric USD volatility risk
- Even modest beat on US jobs data may fuel risk aversion
The markets appear increasingly convinced that recent market volatility will undermine the Fed's December forecast for 100 basis points in cumulative interest rate hikes this year. The priced-in 2016 policy outlook implied in Fed Funds futures pricing has been sinking since the start of the year and now suggests traders are dubious of the likelihood of even one 25 basis point increase in the baseline lending rate.
Interestingly, investors' dovish conviction appears to clash with the trends in fundamentals defined in the Fed's policy mandate. The latest readings on core inflation measured by both the CPI and PCE gauges put price growth at multi-year highs. Meanwhile, the unemployment rate remains at the lowest level since 2008.
The markets' view also appears impervious to hawkish Fed-speak. The latest FOMC policy statement maintained a conspicuously open-minded posture even as it acknowledged the latest shakeout in asset prices. This week's comments from Fed Vice Chair Fischer - wherein he openly suggested that market dislocation similar to the 2016 episode thus far passed without a lasting impact - made headlines not for their hawkish implications but for a passing mention of negative rates outside the US.
On balance, this creates a significant skew in volatility risk for the US Dollar as January's jobs data comes across the wires. A soft result is unlikely to offer enough novelty to fuel a big-splash response considering the already profoundly dovish lean in expectations. On the other hand, even a modest upside surprise may catch investors wrong-footed and inspire aggressive repositioning, sending the greenback swiftly higher.
--- Created by Ilya Spivak, Currency Strategist for DailyFX.com
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