Fundamental Forecast for US Dollar:Â Neutral
– Rate forecasts are fully pricing a December 14Â hike, with Feds funds calling a 100% chance of a move.
– The speculative burden is now on February and beyond – the Fed’s expectations glide path.
– The US trade agenda under new president will compete with Fed rate forecasting and strength in counterpart weakness.
Though the ICE Dollar Index (DXY) closed out this past week at its highest level in over 13 years, there was a notable downshift in bullish momentum. Following the strongest two-week rally since the currency topped out in early 2015, the benchmark currency barely eked out a bullish close through a period restrained by holiday liquidity. The currency’s primary effective driver – Fed rate forecasts – has enjoyed a remarkable run but is quickly burning off its fuel. Can the expectation of 2017 rate hikes pick up the responsibility for further Dollar gains? Will the threat of US trade barriers take over the responsibility of lifting the speculative value of the Dollar at the detriment of its largest trade partners? The bullish course is not particularly easy to chart ahead.
This past week, the Dollar managed its third straight positive close; but the gains were far less material than what was achieved in the two weeks immediately following the US Presidential election. This was not simply a flush of optimism following the outcome of the closely watched vote, but it nevertheless supplied the kind of fuel that the Dollar has been able gain considerable traction on. The problem is that these outlets of strength may be tapped without direct – rather than incidental – support. The most prominent bullish engine at risk of spent conviction is the rapid buildup of interest rate speculation.
As of this past week, the market is affording a 100 percent probability that the Federal Reserve hikes at its next meeting on December 14th. We haven’t seen this degree of certainty since the last hawkish policy cycle. In an environment where most are maintaining zero or negative rate policies alongside ever-expanding quantitative easing programs, this unusual tack is a strong fundamental booster. Yet, you can’t push expectations beyond 100 percent. Well, in fact, you can push yield forecasts above that traditional cap in certitude because speculation can go out to a move beyond 25 basis points. That is extremely unlikely however as the group has vowed a gradual pace so as to curb fears as they attempt to normalize policy. Where further bullish premium may be found is through tightening at further meetings.
