The Greenback advanced against all of its major counterparts this past week, and the USDollar secured its strongest two-week rally since the May 2015 climb forestalled a bearish reversal. Such a strong upswell comes with a surprising lack of solid fundamental support. General growth forecasts haven’t improved material through economic updates. Market rate forecasts haven’t budged from deep skepticism. And, we haven’t seen evidence of traditional risk aversion. That leaves speculators in charge. Is there enough conviction from the trading ranks - or perhaps short-covering to work through - to keep the Dollar rising through the coming week? Could traditional fundamentals take up the reins?
We have seen the FX market’s sensitivity to small changes in rate speculation behind the Fed and other central banks deflate some time ago. In fact, over the past weeks; there was remarkably little speculation to arise from the FOMC decision (and statement), US 1Q GDP and April NFPs. The burden of leveraging a heavy Dollar swing on the basis of the next hike being moved forward or back by three months has risen sharply. On the one hand, skepticism over the Fed’s ability to hike again in the current environment has grown exceptionally resolute. It would take a considerable shove to raise the speculation of a June hike - currently swaps and Fed Fund futures price no chance (0% probability). The more systemic issue is that themarket is less responsive to relative monetary policy as the variances are realistically very small, and skepticism over its efficacy is rising – particularly at the extreme dovish end of the spectrum.
In an effort to stimulate these flagging rate interests, there are a few indicators of pertinence scheduled for release. The top attempt to revive appetite for front-running the Fed yield will come from the consumer inflation report (CPI) for April. The core, annual inflation rate is expected to slip a little further from its seven-year high set in February with a 2.1 percent reading. It is the headline price reading that has acted as the strongest break on rate hikes, but it thereby also poses the best potential. An estimated 0.2 percentage point rise to a 1.1 percent pace would still find the reading far from its target, but the rise in commodity prices may bolster forecasting among FOMC officials and traders. In fact, the rise in oil between March and April represents the biggest two-month rally since June 2009.
Though traditional fundamentals seem an easier source to plot a fundamental value, the deeper potential rests with speculative appetite and positioning. The three-month decline for the Dollar through April set the stage for a speculative imbalance where the reach stretched behind traders’ comfort. On a short-term basis, retail speculators had leveraged the call for a bullish reversal with the SSI on the USDollar hitting its highest level since July 2014. With the two-week rally, their appetites have been quenched, but the deeper pockets are still sitting at an extreme. The CFTC’s Commitment of Traders (COT) report showed net speculative positioning among large futures traders nudged up modestly (by 38,063 contracts), but relative exposure still remains distinctly extreme with the market just off its most bearish position in two years – coming from significant, net long holding. This may render the fuel for a ‘short squeeze’.
It has been the case, and will remain so, that the greatest potential to move the Dollar and financial markets is a shift in risk trends. The three-month rally in risk-oriented assets has started to falter, and a deepening of that slide could certainly agitate some haven appeal for the Greenback. However, full-scale risk aversion is the thousand point weight swinging above the market and what would most effectively leverage the depth of haven appeal that would activate the currency’s haven status. That said, we may not need such an extreme. With fears of currency wars growing, FX volatility could make for a more ready driver. Watch this week’s G-7 meeting for FX mentions.