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Video: Dollar Faces A Heavy, Bearish Skew for Fed Rate Speculation

Video: Dollar Faces A Heavy, Bearish Skew for Fed Rate Speculation

John Kicklighter, Chief Strategist

Talking Points:

  • Interest rate expectations for a March 15 hike from the FOMC soared to 94% this past week
  • Despite the surge in hawkish anticipation, the Dollar Index gained little ground - and actually lost it versus the Euro
  • A scenario where the Fed's hawkishness grows next week carries far less potential than if it tempered its outlook

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Speculation can be remarkably efficient with pricing in information. It can also create extreme imbalance in the market. When particular views or scenarios turn into virtual certainty amongst the speculative rank, it can create a skew in the course of the fundamental path the market takes. This has been well illustrated through risk trends. The assumption of a market that is committed to the chase for yield has promoted risk taking with a dangerous apathy towards the risks that it would represent. For a few more basis points return on a record low rate environment, investors are willing to pile on exposure and thematic leverage. From the likes of the S&P 500 and other US equity benchmarks, it would seem that this isn't a limiting factor - but it has so far found a continued drip feed of fundamental support. The US President has supplied the market in the absence of other critical theme, but that half life seems to be cycling down.

For the Dollar, the skew is arguably more extreme and the options for motivation far fewer. An early shift in monetary policy from the Federal Reserve starting with the Taper back in 2013 set the currency on course for a multi-year advance based upon a very unique fundamental skew. That advantage grew when the central bank actually hiked rates while the likes of the ECB, BoJ and BoE increased stimulus efforts. Now on course for an acceleration of the Fed's pace, it seems the market has found a saturation point for the Dollar's rate advantage - at least until there are yields that inspire genuine long-term investment rather than short-term speculative mover action. This past week, the probability of a March 15 hike increased from approximately 40 percent to 94 percent. Virtual certainty. From the Dollar, the market wouldn't even gain a percent on an index basis and actually tumbled after Yellen added the period to the communication.

Moving forward, monetary policy will remain a critical theme for the Dollar, FX market and financial system as a whole. However, the Fed's scenarios will be heavily skewed in possible market movement. Crawling the last few inches to absolute speculative certainty on next week's hike will likely render far less ground for the USD. Accelerating views of pace is possible, but the chances of four hikes in 2017 already stands at 17 percent - remarkably high. Alternatively, if developments (like February NFPs) temper the rate forecast, there is plenty for the hawkish currency to lose. Asymmetries like these are not uncommon in the markets, but this one seems potent. We loaded scenarios in this weekend Strategy Video.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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