US Dollar Slow To Respond To Risk Trends, Fed Keeping It Back?

Fundamental Forecast for Dollar: Bullish

The Dollar still carries the glow of last month’s Fed hike and there is a new – and traditionally favorable – wind blowing in the currency’s favor: risk aversion. Yet despite, the encouraging fundamental circumstances, the Greenback is showing little of the drive it had enjoyed the past few years. The equally-weighted USDollar Index has inched up to a 12-year high while the trade-weighted ICE Dollar Index is virtually unchanged. Drives for commodity-currency based majors (USDCAD, AUDUSD, NZDUSD) and the tumble in the Cable (GBPUSD) seem to have more to do with counterparts than the Dollar itself. EURUSD, the world’s most liquid currency pair, perhaps best reflects the situation with a minor anti-dollar close week-over-week.

If the fundamentals are favorable, why isn’t the currency performing? Price action is a consensus of the market’s views. What seems clear in an academic interpretation may find the masses place the emphasis on value somewhere else. We were already seeing the weight given to the Fed’s competitive monetary policy bearing fade through the closing months of 2015. After the first rate hike, that conviction further cooled. With considerable premium afforded the Dollar for the first rate hike and most scenarios of a dovish turn boding just as poorly for FOMC counterparts, the greatest potential is for the USD finding broader appeal for an accelerated rate path. Yet, that will be difficult to accomplish in current conditions – amid struggling capital markets and commodity deflated inflation expectations.

Rate speculation has a date to contemplate: January 27 when the FOMC next meets. Yet, the market places a low probability on a hike so soon after December’s launch. Nevertheless, the coming week’s docket will help shape the discussion of timing/pace. Chief rate fodder will be the US consumer inflation statistics (CPI) due Wednesday. Price pressures are the primary restraint to a more aggressive tightening pace, but the tepid inflation figures are effectively curbed by the deep dive in commodity prices. It is unlikely that we see the case for a hike this month develop from this data.