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Dollar Ends Busy Week with Rate Boost, Could Its Safe Haven Appeal Kick In?

Dollar Ends Busy Week with Rate Boost, Could Its Safe Haven Appeal Kick In?

US Dollar Fundamental Forecast Talking Points:

  • Though the Fed hiked its benchmark rate 25bps this past week and spoke for further moves ahead, the market didn’t seem to believe until after the big NFPs number
  • Market-based rate forecasts are now pricing in a peak rate of 5.00-5.25 percent in-line with the Fed’s view…but there are still projections of cuts in 2H
  • With EURUSD and USDJPY tentatively stepping into trend reversals, the Dollar’s ‘safe haven’ role is the most potent catalyst to watch going forward
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Fundamental Forecast for the US Dollar: Bullish

The US Dollar managed to finally generate significant volatility this past week, breaking a long stretch of indecision that formed statistically-extreme congestion. The question now is whether the jolt was enough to restore some trend to the currency. For that to be the case, the market will need to tap into one or more of the waylaid systemic themes behind the benchmark. We saw the monetary policy function stirred this past week between the FOMC’s rate hike and a run of strong economic data that was led by the big beat in nonfarm payrolls (NFPs). There is a market discount to the central bank’s own monetary policy forecast, so there is potential for this channel to facilitate some lift for the Dollar. That said, if there were a singular outlet of greatest potential for momentum (in either direction), it would be the possibility of a sharp ‘risk aversion’ recharging the safe haven function of the Greenback. From a technical perspective, the DXY Dollar Index still maintains a broader four-month downtrend from its multi-decade high. There is a larger channel and 50-day simple moving average (SMA) above that could challenge intent, but the today charge through Friday certainly has the FX market’s attention.

Chart of DXY Dollar Index with 50 and 100-Day SMAs, 11-Day Historical Range(Daily)


Chart Created on Tradingview Platform

Plotting the aforementioned, systemically-important fundamental themes over the benchmark currency; there was some support through both the rate forecast and ‘risk’ venues. However, I would ascribe much of the Dollar’s charge through the end of this past week to the bounce in market-based risk forecasts. With a bounce in the implied rate from Fed Funds futures and a rise in 2-year Treasury yields, it would seem that the market’s insistence that the US central bank will not be able to hit its own forecast for a terminal rate (5.125 percent according to the SEP) has wavered. While the 25 basis point rate hike and Chairman Powell’s rhetoric after the policy meeting this past week would have registered as capable of fostering this view, it was more likely the significant beat in NFPs (a net 517,000 increase beating forecast by 332,000) and the ISM service sector report (jumping to 55.2) that forced the market to curb its push against the Fed’s credibility. The market has ‘made hay’ by discounting the central bank’s forecast for the past months, but that is not a convergence in views that is likely to move fast nor far. If there is a strong follow through in the week ahead, it is likely to come through the Dollar’s safety function – something that can be appreciated through the correlation to the VIX and recognition as to the general position of that index.

Chart of DXY Dollar Index Overlaid with the VIX Volatility Index (Daily)


Chart Created on Tradingview Platform

For Dollar-based crosses of interest, EURUSD is one of the top for me. It is the most liquid currency cross in the world and thereby a distinct reflection of the benchmark currency. More than that, it speaks to the fundamental themes that we are monitoring. The safe haven / volatility correlation is certainly registered here (inverted as the Dollar is the second currency), but this pair has more interest rate speculation consideration than most. Looking across the spectrum of rhetoric and unofficial projections for monetary policy trends, many of the major players have signaled that they are closing in on the end of their tightening cycles for the time being. The BOC made it explicit, the BOE was all-but announcing its intent while the RBA and RBNZ have similarly backed off – all seen in swaps projections. The outlier is the ECB which hiked 50bps this past week and indicated that at least another move of that same magnitude were ahead. The European central bank is behind the curve and playing catch up. That would normally suggest that there is more Euro potential ahead in the ambiguity of the terminal rate, and yet EURUSD has still edged the floor of its rising trend through week’s end.

Chart of EURUSD with 50 and 100-Day SMAs, 2-Day Rate of Change (Daily)


Chart Created on Tradingview Platform

For USDJPY, the disparity between the market and Fed view on interest rate projections will still play a role. Here, the Bank of Japan is not really adding much to the forecast given their reticence to follow up on December’s surprise expansion of its 10-year JGB band. That said, the plateau in US rates draws significant scrutiny relative to the pair’s slide. That said, ‘risk appetite’ is a far more provocative possibility here. While the Yen is often treated as a haven currency, its role is more appropriately as a ‘funding currency’ in carry trade that is unwound when sentiment declines. Yet, USDJPY has already unwound half of its advance between 2021 and 2022 and this happened as risk appetite was on the rise in traditional assets like equities. The safe haven in this pair is likely to be the Dollar – and the correlation to the VIX reinforces that perspective. If risk appetite is steady in the week ahead, it will likely happen at a crawl. Alternatively, if sentiment falters, it is more likely to unfold more aggressively. That imbalance of possibility and potential in scenarios is interesting.

Chart of USDJPY with 50 and 100-Day SMAs, Spot to 20-Day Differential Index (Daily)


Chart Created on Tradingview Platform

Finally, taking a look at the scheduled docket to see what event risk could reasonably be expected to stir the discussion around either or both of these themes, we find an exceptionally quiet outlook. With perhaps the exception of the University of Michigan consumer confidence survey on Friday, there aren’t any listings here that I would say carry a high probability of changing the perspective of the masses. That may frustrate some fundamental traders, but I consider it a boon. When there is an overabundance of event risk (like last week) it can turn volatility erratic and actually prevent the development of a clear view. Now, we can see sentiment around theme and market develop more organically, and perhaps garner some real traction.

Top US and Global Macro Event Risk Next Week


Calendar Created by John Kicklighter

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