Talking Points:
- The Dollar's tumble through 2017 and January was heavily based on the strength of its most liquid peers
- With the ECB and BoJ rate decisions and cooling of Brexit language, the Dollar will find itself more in control moving forward
- The return of sway doesn't necessarily translate to a bullish Dollar view, monetary policy and protectionism will be key themes
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The Dollar's Passive Slide
For the past year, the Dollar has been driven lower by the strength of its most liquid counterparts. Perhaps the most prominent example of the Greenback's performance is the EUR/USD's remarkable turn from a more-than-decade low to a charge of more than 20 percent that now finds the it at three-year highs. Though the Dollar's own fundamental backdrop plays a part in this performance, its role has been more that of a static anchor around which more active counterparts have gained strength. From the themes that have been most prominent over this period, we have seen a strong but static view on interest rate expectations, growth forecast, appeal for return and fiscal policy. Speculation value change above all else and it has simply been outshined.
In a relative market like FX, there are always two factors from which to derive value: technically the base and countercurrency in a currency pair. The Dollar's vast advantage for liquidity usually secures its status for moving its counterparts rather than the other way around. However, when those counterparts are aligned collectively and the Greenback is adrift, the balance of power will shift. That has the been the case this past year. The Euro has done much of the heavy lifting as the second most liquid currency with speculation of a monetary policy swing drawing traders to comparison to the sweeping performance the Dollar wrought back in 2014-2015 - along with a political stability appeal that was recently massaged with the German coalition talks. From the Pound, an improved outlook for Brexit provided a bid for a currency at deep discount. More recently, the Yen generated traction when the market recognized a change in BoJ QE activity which was extrapolated to suggest a full policy change ahead. Collectively, the anti-Dollar gain was a strong one.
Crosswinds Fade and Grow Turbulent
If the Dollar's benchmark counterparts could continue to leverage a collective advantage advance, it would be difficult for the Greenback to overcome. Yet, that uniform schadenfreude has notably hit the skids recently. Just this past week, the European Central Bank shot down expectations that a more definitive policy shift was at hand. Draghi said that a rate hike in 2018 was an unlikely event and he revived his concern over the level of the Euro. For the Japanese Yen, the Bank of Japan was characteristically stoic in their commitment to its ever-expanding stimulus effort, curbing the most recent of the contributors to the cabal. And, as for Brexit, the friendly tones have already tempered under accusations that both sides are unclear on their position.
A Dollar In Control is Not Necessarily Bullish
With the Greenback retaking the reins of its own bearing and tempo, the natural assumption is that it is primed for a recovery from a 'discounted' position. That is not necessarily true. Turning back to the fundamental picture the US will shape, there is distinct possibility for bullish or bearish development; but collectively, it looks as if it will certainly provoke response. On monetary policy, the markets own forecast for US rates continues to rise with Fed Funds futures implying a decade high 2.05 percent yield through year's end. Our docket is loaded for events to weigh in on this theme between the Fed's favored inflation indicator (PCE deflator), the NFPs with wage growth and even a Federal Reserve rate decision. Perhaps more effective a catalyst nowadays though is the focus on protectionism. A temporary salve but long-term global poison was revived this past week with the policy promotion of the Trump administration in Davos. Will the State of the Union solidify this withdrawal from global capital circulation or be known for the long-awaited outline for the infrastructure program? We discuss the Dollar's drivers and trend in this weekend Quick Take video.
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