Fundamental Forecast for Dollar:Neutral
- The further price moves away from yields, the greater the risk of a snap back due to rate expectations
- Key event risk includes Treasury auctions, consumer sentiment and activity indexes; but PCE is the top listing
- Watch the volume on dollar-based majors with the release of NFPS using the FXCM Real Volume indicator
The US Dollar has advanced for six consecutive weeks. That represents the most consistent run for the currency since February of last year – which happened to be the most prolific leg of a two-year bull run through the July 2013 peak. While the dollar’s move this time around is more discrete and less momentous than its predecessor, the consistency is nevertheless impressive. Where traders should be concerned is that the difference may extend to the broader extension of the larger trend. Looking into the dollar’s backdrop, there is little of the fundamental motivation we would normally expect the currency to advance on. Without a turn in speculative appetites, groundswell in the market’s rate forecasts or material drop in other majors; the dollar’s rally is likely to stall.
While this past week highlighted a number of impressive moves from benchmarks (Dollar, S&P 500, Yen crosses), trend development is still difficult to maintain in an environment of complacency. And, a lack of conviction is still the most universal aspect of the financial system. A prime example: from the S&P 500’s drive to fresh record highs, the market failed to top 2 billion shares for the week – one of the quietest non-holiday trading periods on recent records. Participation in even the most prolific trends is lacking.
So, if there is a lack of drive to the markets, why have US equities and the dollar gained so much ground recently? For the Index, the motivation was speculation. The swell in ‘risk premium’ through the first half of the month presented traders another opportunity for short-term gains so long as volatility remains deflated. That premium has since been exercised, and further gains now fall more on the shoulders of true trend development. A similar opportunistic appeal was seen in the currency. Motivated declines in key counterparts – Euro, Pound, Yen – translated into consequent gains for their most liquid counterpart. Once again, progress from here requires more.
Looking out over the coming week, the need for an active catalyst is much greater. From a cross-currency gains perspective, USDJPY needs robust speculative appetite to advance; GBPUSD has already slid seven strength weeks (matching the longest decline in decades); and the retreat in NZDUSD has put the kiwi into an almost excessively dovish light. As the FX market’s most liquid pair, EURUSD could strong-arm dollar gains, but there is limited cannon fodder to supply that motivation.
The long-elusive risk aversion theme that could leverage the dollar’s safe haven status is a very high potential candidate, but a dedicated deleverage is a low probability. Moreover, the currency’s full appeal in this all-consuming theme only really hits its stride when the need is liquidity – not just booking profit. A pullback in US equities after this past week’s premium drawdown is likely, but the necessary conviction to fully turn this trend may be beyond what the market’s participation levels are capable of.
As has been the case for some months, the dollar’s most accessible source of untapped strength is an upgrade in interest rate expectations. While the consensus of economists and money managers is for a first hike sometime mid-2015, the market is positioned for something far more distant. Even the Fed’s end-2015 and 2016 rate forecasts (1.12 and 2.50 percent respectively) are met with serious skepticism by the market (0.72 and 1.70 percent). The cadre of unscheduled Fed speakers – and Chairwoman Yellen – this past week was unable to close the gap. The calendar this week may be able to make a dent between economic activity, housing and sentiment readings. However, the most prominent listing will be Friday’s PCE - the Fed’s favored inflation reading. If this theme fails to step up, we may find the dollar stalled or even in retreat.