The Dollar Forecast Don’t Count On A Dovish Fed

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The Dollar Forecast: Don’t Count On A Dovish Fed

The Dollar, It Retraced Itself

The dollar index has given up all but the last little bit of its 2020 gains. The move is driven by an increasing expectation the FOMC will cut rates this year and that expectation based on the coronavirus. The coronavirus is spreading around the world, mark my words, the Wuhan Flu is coming to a neighborhood near you. But it’s not that big a deal, not really. No more than a bad case of the flu the pandemic is largely expected to run its course and then we’ll all be back to business. The biggest threats are to corporate earnings and GDP growth.

The Fed, for its part, is still data driven and the data is good, the U.S. economy on solid footing despite two years of trade war. I’ve not know the Fed to act pre-emptively ever so the hope they will try to front-run viral impact to the U.S. economy is misplaced. At least in my opinion. This week we may see things change, there is quite a bit of data on tap, but I don’t think it will support the idea of 1 much less 3 FOMC rates this year.

Topping the list is the Beige Book. The Beige Book report is due out on Wednesday, it is a summary of economic activity across the 12 Federal Reserve operating regions. They key information within this report will be the labor data. The Fed has been reporting tight labor conditions, shortages of workers, and rising wages for many quarters. If that changes we may be in for a deep market correction and contraction of the dollar but I don’t think so.

Along with the Beige Book is the monthly labor data bundle including the ADP, Challenger, and NFP reports. These should show job gains, unemployment, and wages on trend if not accelerating. With that scenario in play, the outlook for the FOMC and rate cuts is going to change and that I think will put a bottom back in the dollar.

The DXY Technical Analysis: Ranges Rule, The Next Leg Is Probably Higher

The DXY shed close to -3.0% over the last week as traders flooded into safe-havens like gold and the yen. This move has erased nearly all the 2020 gains but has not broken support. My best support target is near $97.12 and, so far, buyers are holding prices well above that level. The long-term trend in the dollar is sideways. The $97.12 level is near the bottom of the long-term range so I expect it to hold and confirm as support and point of reversal. That could happen this week as the data is released so traders are cautioned to not get overly bearish with thier dollar trades this week.

Market Extra

Anneken Tappe

Demand for a haven appears to outweigh rate pause

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A closely followed dollar index recorded its biggest percentage gain in six months, as the currency’s status as a haven appears to be trumping the Federal Reserve’s dovish tilt.

Mounting worries over global growth prospects are providing the dollar with the sort of haven appeal that’s often reserved for the like of the Japanese yen USDJPY, -0.06% or Swiss franc USDCHF, +0.02% , given that the U.S. economy is still holding its own — at least for now.

The ICE U.S. Dollar Index DXY, +0.06% is on track for a 1.1% gain last week, the biggest weekly percentage jump since August. On Monday, the trend continued and the gauge strengthened.

The dollar at times follows the direction of U.S. government bond yields TMUBMUSD10Y, 0.596% , which are both perceived as a safe and very liquid asset but also sensitive to U.S. interest rate expectations, particularly at the short end. Yields, which move in the opposite direction of prices, have declined since last week’s Fed meeting, as both lower rate expectations and global growth worries took hold.

“Treasury moves are still leading the way for both equities and the U.S. dollar. Treasury [prices] advance as risk aversion remained the dominant theme for the end of the week, with the greenback gaining on safe-haven flows,” wrote Edward Moya, market analyst at Oanda.

The Fed late last month surprised investors by striking a dovish tone at its first policy meeting of the year, signaling that interest rates were on hold until further notice just six weeks after having delivered is fourth hike of 2020. The move sent the yields and the dollar tumbling, while stocks rallied.

The dovish Fed was expected to keep pressure on the dollar. After all, the opposite, hawkish, approach of the central bank helped the dollar all of last year. Currencies are commonly supported when domestic interest rates are moving higher, as stronger yields makes assets denominated in the currency a more attractive destination for investors.

But even though the Fed stepping off the gas should ordinarily be dollar-negative, it might just be trumped by the worries of a world-wide slowdown.

The European Central Bank last month said risks to the eurozone’s economic outlook had shifted to the downside, while the European Commission last week slashed its outlook for growth across the region. The Bank of England last Thursday forecast 2020 U.K. gross domestic product would grow at the slowest pace since 2009.

And concerns remain over the prospect of a hard landing for China’s economy as it deals with a host of headwinds and the trade dispute between Beijing and Washington.

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Meanwhile, history shows the dollar tends to perform well when the global economy doesn’t, though market participants stressed that this thesis only holds as long as the U.S. economy withstands a slowdown of its own. And for now, the U.S. economy still looks healthy, particularly in comparison with its peers.

A strong January jobs report, for example, led the dollar higher last week, outweighing the Fed’s calls for patience that had pushed it down just one day before.

That being said, many expect softer U.S. economic data in the second half of the year.

“With the United States tackling headwinds in the form of trade tensions, global growth fears, fading fiscal stimulus at home and political uncertainty in Washington, dollar is certainly vulnerable to downside shocks. Any signs of the U.S. economy experiencing a slowdown will most likely accelerate dollar depreciation as its safe-haven status is questioned,” said Lukman Otunuga, research analyst at FXTM.

Meanwhile, the more pessimistic are penciling in a recession by 2020, arguing that the Fed’s decision to pause will end up marking the end of the hiking cycle and that the next rate move will be a cut.

US Dollar May Rise as Data Flow Drives Rethink of Fed Policy Bets

US DOLLAR FUNDAMENTAL FORECAST: BULLISH

  • US Dollar gains as Fed’s Powell unpacks updated policy framework
  • On-trend core inflation clashes with dovish shift in rate hike outlook
  • Incoming news may fuel rebound as ‘data dependence’ is established

The US Dollar fell for a third consecutive week, succumbing to weakening yield- and haven-based appeal as priced-in Fed rate hike prospects fizzled while risk appetite recovered. Futures markets now predict the central bank will forego tightening altogether in 2020. Meanwhile, the bellwether S&P 500 index has climbed to the highest in a month.

A snapshot of weekly performance obscures what looks to be a critical change in the underlying fundamental narrative however. Markets have been taken with the idea of a dovish turn in the consensus view on the FOMC policy-setting committee for some weeks. Last week, Chair Powell seemed to ratify the idea that – while a change in posture has indeed occurred – this does not imply commitment to a directional bias .

POWELL CHECKS DOVISH TURN IN FED POLICY OUTLOOK

In fact, this seems to be the substance of the adjustment. In the decade following the Great Recession, the Fed sought to reassure markets with policy stability by telegraphing its moves well in advance. With the stimulus withdrawal process underway in earnest and the so-called “neutral” rate in sight, officials have moved into fine-tuning mode: dispensing with pre-commitment and adopting a nimbler approach.

Speaking at the Economic Club in Washington DC on Thursday, Mr Powell spelled out in the clearest terms yet that this need not be inherently dovish. He once again acknowledged a plethora of potential headwinds including trade tensions with China, shaky European politics and the ongoing US government. Critically however, he asserted none of these have materially soured incoming economic data flow.

The Greenback offered a telling response, rising alongside bond yields as the priced-in policy path implied in Fed Funds futures edged away from recent dovish extremes. More of the same followed as December’s CPI report underscored Powell’s point on the very next day. The headline price growth reading ticked lower courtesy of a slump in crude oil, but the core measure held reassuringly on-trend at 2.2 percent.

US DOLLAR EYEING BARRAGE OF ECONOMIC DATA

The calendar is loaded with economic activity data in the coming week. Figures on inventories, retail sales, industrial production, housing starts and building permits are all due. The University of Michigan will also update its US consumer confidence gauge. If traders have finally onboarded what the Fed is saying, the expectation of open-minded data dependence might see any of these stoke outsized volatility.

US economic news flow has sharply improved relative to consensus forecasts since the calendar year turn. That suggests the setting of analysts’ models has been much too pessimistic, opening door for continued outperformance on incoming releases. That may well prompt a deep rethink of the markets’ no-hike 2020 policy view, setting the stage for the US Dollar to recover.

— Written by Ilya Spivak, Sr. Currency Strategist for DailyFX.com

To c ontact Ilya, use the comments section below or @IlyaSpivak on Twitter

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