Fundamental forecast for the US dollar: neutral

  • Fed rate hike expectations have risen in recent weeks. If the FOMC disappoints, the US dollar could be in trouble.
  • What makes the US dollar so vulnerable to an FOMC disappointment? Positioning in the futures market – which remains close to its longest level since October 2019.
  • According to the IG Customer Opinion Index, the US dollar has a mixed bias around mid-January.

US Dollar Week in Review

The US Dollar rebounded last week, with the DXY Index closing up +0.49%, nearly erasing its month-to-date losses (though still -0.04% lower in January). With the drums of European war beating louder, EUR/USD rates recorded a loss of -0.62%, while GBP/USD rates fell -0.86%. Weakness in risky assets duly fueled demand for safe havens, with USD/CHF rates down -0.22% and USD/JPY rates down -0.43%.

US economic calendar in brief

Next week’s economic calendar will prove to be substantial. The Federal Reserve’s first policy meeting of the year has already fueled much speculation in financial markets, with high expectations for hints of an accelerated rate of monetary tightening. Wednesday’s FOMC meeting could represent a significant turning point for a number, not just for the US dollar, but for all currencies and asset classes.

  • On Monday, January 24, the US Chicago Fed’s December National Activity Index will be released in the morning ahead of the January Markit US Manufacturing PMI report.
  • On Tuesday, January 25, the November U.S. House Price Index is due 30 minutes before U.S. stock markets open, while the January U.S. Consumer Confidence Indicator will be released 30 minutes after the start of trading. trading in US stocks.
  • On Wednesday, January 26, weekly data on US mortgage applications are due, as is the US goods trade balance for December, before US stock markets open. US new home sales figures for December will be released later this morning. The Federal Reserve’s January rate decision and Fed Chairman Jerome Powell’s press conference will arrive at 14 EST/19 GMT.
  • On Thursday January 27, the December US Durable Goods Orders report, the initial US Q4 21 GDP report and the weekly US Unemployment Claims figures are due in the morning. U.S. pending home sales in December will also be released.
  • On Friday January 28, the US PCE price index for December is due, as are the personal income and personal expenditure figures for December in the United States. The Michigan US consumer sentiment report for January is due later this morning.

Atlanta Fed’s GDPNow growth estimate for Q4 2021 (January 19, 2021) (Chart 1)

US Dollar Weekly Fundamental Forecast: Will the Fed Derail the Dollar Rebound?

Based on the data received so far on 4Q’21, Atlanta Fed GDPNow The growth forecast now stands at +5.1% at an annualized rate, against +5% on 14 January.the nowcast for growth in real gross private domestic investment in the fourth quarter fell from +18.1% at +18.6%. »

The latest update to the Atlanta Fed’s GDPNow growth forecast for Q4 21 is due on Wednesday January 26 following the release of the December US Goods Trade Balance and US New Home Sales figures. United in December.

For full american economy data forecasts, view DailyFX Economic Calendar.

Market prices point to an aggressive Fed

We can measure whether a Fed rate hike is priced in using Eurodollar contracts by looking at the difference in borrowing costs for commercial banks over a specific time horizon in the future. Graphic 2 below shows the difference in borrowing costs – the spread – for the February 2022 and December 2023 contracts, to assess the direction of interest rates by December 2023.

Eurodollar futures spread (February 2022-December 2023) [BLUE], USA 2s5s10s Butterfly [ORANGE], DXY Index [RED]: Daily chart (August 2021 to January 2022) (Chart 2)

US Dollar Weekly Fundamental Forecast: Will the Fed Derail the Dollar Rebound?

By comparing the odds of a Fed rate hike with the US Treasury butterfly 2s5s10s, we can assess whether or not the bond market is acting in a manner consistent with what happened in 2013/2014 when the Fed signaled its intention to reduce its QE program. The 2s5s10s butterfly measures non-parallel shifts in the US yield curve, and if the story is accurate, that means mid-rates should rise faster than short or long rates.

There is 156.75-bps of discounted rate hikes through the end of 2023 while the butterfly 2s5s10s is right next to her widest gap since Fed tapering talks began in June. Ahead of the Fed’s January meeting, rates markets are effectively pricing a 100% chance of six 25 basis point rate hikes and a 27% chance of seven 25 basis point rate hikes until the end of next year. In addition, expectations of a 50 basis point rate hike to start the hike cycle have risen slightly in recent weeks.

U.S. Treasury Yield Curve (1 Year to 30 Years) (January 2020 to January 2022) (Chart 3)

US Dollar Weekly Fundamental Forecast: Will the Fed Derail the Dollar Rebound?

The retracement in Fed ratings hikes coupled with lower US Treasury yields poses a problem for the US Dollar, however. If the FOMC makes it clear that it won’t raise rates by 50 basis points in March, or suggests that inflationary pressures should ease further – implicitly suggesting that aggressive tightening is not warranted – then the US dollar remains vulnerable to another decline.

CFTC COT US Dollar Futures Positioning (January 2020 to January 2022) (Chart 4)

US Dollar Weekly Fundamental Forecast: Will the Fed Derail the Dollar Rebound?

Finally, a look at positioning, according to the CFTC’s COT for the week ended January 18, speculators reduced their net long positions in the US dollar to 36,402 cthe contracts of 37,860 contracts. Despite falling for two weeks, the US dollar’s net long positioning remains near its highest level since October 2019, when the DXY index traded above 98.00. The oversaturated net long position in the futures market remains a significant drag on the upside of the US dollar in the short term.

— Written by Christopher Vecchio, CFA, Senior Strategist

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