Fundamental Forecast for Dollar:Neutral
- The Jackson Hole Symposium and CPI data look to revive rate speculation – for better or worse
- Volatility has eased, but the general trend is still moving higher
- Watch the volume on dollar-based majors with the release of NFPS using the FXCM Real Volume indicator
The two headline themes for dollar watchers – the Fed’s place in the rate forecast and appetite for safe havens – offered the greenback little fundamental bid this past week. And yet, the dollar held up well. This stability through unfavorable circumstances is unlikely to hold out forever however. In the past month-and-a-half, the currency has reversed from a significant escalation of a bearish trend bearing and subsequently marked impressive gains. Yet, without fundamentals to support the move, the speculative drive can easily collapse on itself.
If we were to refer to the indicators used to track the major fundamental themes, it would seem that the dollar’s greatest fundamental concern would be the diminished sense of fear in the financial system. The S&P 500-based VIX Volatility Index dropped sharply from the rapid climb over the previous weeks. This deflated ‘risk’ was not unique to equities, but the retreat was far more moderate for asset classes like FX and rates. What is interesting though is that the greenback has not suffered substantially from the rebalance. This is likely because the currency’s advance was not particularly dependent on the swell in the first place. The reserve currency is considered a liquidity haven – a more extreme measure of safe haven.
Furthermore, though much of the edge was dulled in the volatility indicators, the underlying trends are still rising. From positioning in the capital markets, we also see a reticence to return to the same level of exposure and leverage that have become the hallmarks of complacency and contentedness. US equity indexes (S&P 500 and Dow) are slow to return to record highs, while European benchmarks haven’t even put up a convincing recovery. Elsewhere, one of the more popular short-term speculative trades – selling jumps in volatility via ETFs, futures and options – has substantially abated. This isn’t evidence that a wholesale unwinding of risk is imminent, but it does show a crack in speculative build up.
While risk trends can override all other themes when active, the dollar is more likely to find an active driver in interest rate expectations. This past week, data pertaining to policy speculation was light. However, there were a few Fed opinions that show how contentious the debate over stimulus and interest rates is amongst the FOMC. Known-dove Kocherlakota remarked that the economy is still far from its policy objectives and a hike in the near future was unwarranted. A direct contrast, regular hawk Bullard said they were closing in fast to their employment and inflation objectives, which has shaped his expectations for a hike in the first half of next year.
According to economists polled by Reuters and Bloomberg, the timing for the first rate hike still projects a mid-2015 move. That is similar to the Fed’s own time frame. And yet, the market continues to discount those forecasts. Is the market truly skeptical for the timing of the first move and subsequent pace, or is it simply a reflection of speculative positioning holding out? As evidence mounts one way or the other, we will reconcile this question.
In the week ahead, rate speculation will be fed by two important updates: July CPI and the Jackson Hole Symposium. The consumer price index is not the central bank’s favored inflation reading, but it is the one that the market is more prone to speculate around. Moderation could trip up the dollar, but it is unlikely to ignite a new trend. Alternatively, a pickup in price pressures can close the gap between market and Fed forecasts. The Kansas City Fed’s sponsored event to discuss economic, monetary and financial issues will generate a lot of interest. This meeting often offers up candid forecasts and opinions that we don’t normally see in normal policy channels. Fed Chair Janet Yellen is on the docket, but the global central banker tone can carry serious weight for general investor sentiment as well.