Dramatic Shift In Fed Expectations Spurs Dollar Gains, But Now What?

The pendulum of market sentiment swung hard and fast toward a Fed rate hike in the middle of March. The signals from Fed officials, including Governor Brainard and Powell, spurred the move. According to Bloomberg, the market had discounted a 90% chance of a hike before Yellen and Fischer spoke. A week ago, Bloomberg calculations showed a 40% chance of a move. Buy the rumor sell the fact activity made for dramatic pullback in the dollar in the US afternoon before the weekend. It likely squeezed out some weak longs.

The key issue is whether, with a US hike nearly fully discounted, it can still be a dollar driver, and if not, what replaces it. We think these questions lend themselves to choppy activity in the first part of the week ahead, and suspect the greenback can rally on a strong jobs report, especially if wage growth picks up again. The market seems to have altered the timing of the Fed’s move more than the pace. We suspect that the market will move to discount a greater chance that the Fed delivers a third hike this year, only a third of which has been discounted.

The Dollar Index gained 0.3% of a percent last week, with the early gains cut in half in the sell-off that took place in the last few hours of activity. It reached 102.25 at its peak, its highest level since January 11, and surpassed the 61.8% retracement of the down move since the January 3 peak (found a little above 102.05). The upper Bollinger Band comes in near there as well. A break of the 20-day moving average, which caught the lows in the second half of February may be the signal that this leg up that began in early February near 99.20 is over. The 20-day moving average is near 101.

A late short squeeze prevented the euro from falling for a fourth week against the dollar. It was the second weekly gain in the past six. It had frayed the lower end of its recent range near $1.05 to test the lower Bollinger Band. It completed the 61.8% retracement of the January rally (~$1.0525). It was squeezed higher ahead of the weekend and entered a technically important area 1.0600-$1.0630. A move above it suggests the February losses have run their course. The area houses the 20-day moving average (~$1.0610), the 38.2% retracement of the recent decline (~$1.0620) and the late February high (~$1.0630).