- The Dollar looks to be jostled by its larger counterparts until rate speculation recovers or risk trends accelerate
- A drop in Yields may be better viewed as a rally in Treasuries – Fed speculation versus haven demand
The US Dollar advanced against most of its major counterparts this past
week, but that doesn’t tell the whole story for the benchmark
currency. In reality, the greenback was essentially little changed.
Fundamentally, the dollar has been left adrift. High profile event risk
has thinned out and the market’s obsession with rate forecasting has
tempered. Yet, we might just find something far more provocative and capable to take up the currency’s reins: risk trends.
The central bank’s decision to abandon its hard targets was a big
factor in the driver’s subsiding potency. Moving forward, rate
speculation’s influence will be driven by data that meaningfully alters
the consensus for timing and the market’s assessment on what is fairly
and fully priced. Looking at Fed Funds futures, we find that the market maintains a sizable discount to the FOMC’s own forecast for rates.
According to the last rate forecast produced after the June policy
meeting, the benchmark rate is seen at 1.12 percent by the end of 2015
(they generally move in 25bp increments, but this is an average) and
2.50 percent by the close of 2016. Yet, we find the market pricing in
0.69 and 1.69 percent respectively.
Event risk over the coming week will carry limited ability to
sway rate forecasts one way or another. For data, we have a small
business sentiment survey, retail sales, upstream inflation pressures
(PPI) and the University of Michigan’s consumer confidence report.
Considering that it took 2Q GDP, NFPs and the Fed’s own monetary policy
meeting to forge the dollar’s advance through the end of July; this
data will struggle for traction.
In the meantime, we may see the FX market’s other dominant fundamental
catalyst take over. While Treasury yields often stand in as a good
proxy for interest rate forecast; they are also a reflection of global
investor sentiment. As a top rated asset that has worked its way into
the category of ‘risk-less’ and ‘cash equivalents’, the fixed income
instruments have become synonymous with safe haven and are particularly
appealing when liquidity is pinched. Separating the demand for yield
from the demand for safe haven can be tricky. But both conditions –
when engaged – are supportive for the dollar.
Over the past year, many have wondered whether the ‘Risk-On-Risk-Off’
relationship has broken down. Given the recent swell in volatility
readings for different asset classes and the building uniformity of
deleveraging showing through in certain assets, the masses are starting
to recognize that it has always been in play…it was simply awaiting
conviction. As measures like the FX Volatility Index show consistency in their climb and
benchmarks like the S&P 500 crash through ever more important
levels of support, the appetite for the dollar (and the market it
represents) will build.
