DailyFX.com - US Dollar Ready for Break…But Direction Awaits Volatility or Fed

Fundamental Forecast for Dollar:Neutral

  • After a disappointing week for yields – despite robust commentary – rate forecasting will focus on Yellen’s testimony
  • Volatility started to move off its historical and seasonal lows last week, but the dollar awaits a true turn
  • Watch the volume on dollar-based majors with the release of NFPS using the FXCM Real Volume indicator

The Dow Jones FXCM Dollar Index (ticker = USDollar) continues to linger conspicuously close to a level that has held the floor on the currency for the past 16 months. Whether the assessment is technical or fundamental, the signs point to a meaningful break for the greenback in the near-term future. However, the direction the market chooses and the commitment to a new trend’s continuity depends on how underlying market conditions evolve and whether the rate forecasts start to solidify.

Perhaps the dollar’s greatest burden moving forward is the maintenance of long-standing complacency in the broader financial markets. Status quo supports the market’s appetite for greater rates of return – even when that pursuit necessitates borrowed funds and greater exposure to fulfill. This all but deflates the currency’s dormant role as a liquidity-centered safe haven currency – an uncontestable position…so long as the market is seeking it out. Furthermore, complacency delays rate expectations for the Fed taking shape across the speculative ranks.

The most capable fundamental catalyst the dollar could face moving forward is a definitive development in risk trends. Yet, here, there is asymmetrical potential. A true and committed swell in speculative appetite that charged high-yield, high-return assets would certainly divert capital from the relatively steady but modest returns in the US. That said, against record use of leverage in the financial system and the premium nearly rung dry from so many of the favored – and even obscure – income assets, it is difficult to inspire a groundswell of risk appetite from current levels. So while it is certainly possible that we meander at exceptionally low market activity levels, the damage from the theme is disproportionate.

Though we seen a number of false dawns before, there was some hope that volatility may be turning a corner this past week. Volatility measures from both the capital and FX markets moved up from their lows. Historically, July sees the biggest average increase in the activity report of any other month – a seasonal shift that can perhaps provoke a turn from the historical depression in these measures. Should market volatility pick up meaningfully, the market’s positioning could prove its undoing. Record highs, record leverage and historically low premium afford little room for a breather before it encourages panicked deleveraging.

Pegging events or data as certain catalysts for speculative impact is difficult. Europe’s recent banking concerns, monetary policy programs changing course and Chinese 2Q GDP are all notable but far from certain influences. When sentiment does sour, it will likely be self-reinforcing. Yet, the initial spark may seem relatively insubstantial (often called the butterfly effect).

Aside from the nuance of risk trends, interest rate speculation promises to be relatively straightforward. This past week, FOMC minutes, Fed member speeches and data seemed to reinforce the idea that the central bank will hike by mid-2015; but neither currency nor yields bore that expectation. Treasury yields may be falling as a side effect of safe haven demand stoking their price, but Fed Funds futures have similarly receded over the period. There is a large discount in the market’s forecasts to even the Fed’s own view of rate forecasts. This presents yet another unbalanced impact potential: not much room to deflate but plenty of scope to swell.

Amid data that ranges from economic health (UofM consumer sentiment, retail sales) to financial activity (TICS flows) to inflation (factory-level price indexes), the most concentrated potential for rate speculation rests in Fed commentary. Speeches by Fisher and Bullard aside, Chairwoman Janet Yellen is scheduled to give her semiannual testimony before congress on Tuesday and Wednesday. Direct questions on growth, stimulus, capital markets and other key topics should capture the market’s interest.

Related Articles
  1. Investing Basics

    Building My Portfolio with BlackRock ETFs and Mutual Funds (ITOT, IXUS)

    Find out how to construct the ideal investment portfolio utilizing BlackRock's tools, resources and its popular low-cost exchange-traded funds (ETFs).
  2. Investing

    3 Things About International Investing and Currency

    As world monetary policy continues to diverge rocking bottom on interest rates while the Fed raises them, expect currencies to continue their bumpy ride.
  3. Chart Advisor

    These 3 ETFs Suggest Commodities Are Headed Lower (COMT,CCX,DBC)

    The charts of these three exchange traded funds suggest that commodities are stuck in a downtrend and it doesn't look like it will reverse any time soon.
  4. Trading Strategies

    4 ETFs To Trade the Russian Ruble (RSX, ERUS)

    Discover which exchange-traded funds (ETFs) provide investors with the greatest exposure to the Russian ruble and learn about the risks that come with each.
  5. Chart Advisor

    3 Charts That Suggest Now Is The Time To Invest In Real Estate (VNQ, SPG,PSA)

    Real estate assets have some of the strongest uptrends around. We'll take a look at three candidates poised for a move higher.
  6. Products and Investments

    Are Dividend Stocks a Good Substitute for Bonds?

    Are dividend paying stocks a good substitute for bonds in a low interest rate environment?
  7. Mutual Funds & ETFs

    When Is the Right Time to Change From Mutual Funds to ETFs

    Find out how to determine when it's the right time for you to switch from mutual funds to ETFs, including the benefits of ETFs and who they are best for.
  8. Investing Basics

    An Introduction To Structured Products

    Structured products take a traditional security and replace its usual payment features with a non-traditional payoff.
  9. Investing Basics

    Understanding Alternative Investments

    An alternative investment is one that’s not among the three traditional asset types – stocks, bonds or cash.
  10. Investing

    New Year, New Investing Strategy: Exploring ETFs

    Whether you’re a seasoned investor or new to the markets, you need to learn as much as you can about the present environment and how to navigate it.
RELATED FAQS
  1. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  2. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  3. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  4. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  5. Do Vanguard ETFs require a minimum investment?

    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>
  6. Can mutual fund expense ratios be negative?

    Mutual fund expense ratios cannot be negative. An expense ratio is the sum total of all fees charged by an asset management ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center