Fundamental Forecast for the US Dollar: Neutral
- US Treasury yields have dropped to multi-month lows, and with inflation expectations still elevated, the erosion of US real yields stands to be a negative influence on US Dollar price action – like it was for much of 2020.
- The June Federal Reserve meeting is likely to formally kickoff taper talk, insofar as policymakers will acknowledge that we’ve moved from ‘potentially talking about discussions about tapering’ to the actual ‘discussions about tapering.’
- According to the IG Client Sentiment Index, the US Dollar has a mixed bias heading through the middle of June.
US Dollar Can’t Catch a Bid
The US Dollar (via the DXY Index) proved feeble in the wake of the May US nonfarm payrolls report, failing to gain any significant upside traction through the week, even around the hot May US inflation report. The DXY Index did manage to gain +0.42% over the past five days, its best weekly performance since the last week of April. But markets seem to have full faith in the Federal Reserve’s point of view that rising price pressures are transitory, as evidenced by the drop in US Treasury yields to multi-month lows.
Further improvement in risk appetite (and downside in US yields) may serve to undercut the US Dollar. Indeed, with measures of market complacency running high (US S&P 500 put/call ratio at all-time lows), it would appear the best shot that the US Dollar has at gaining traction is for a selloff in equity markets. With the Federal Reserve’s June policy meeting this week, the US Dollar is very much in the crosshairs.
US Treasury Yield Curve (1-year to 30-years) (February 2020 to June 2021) (Chart 1)
Another drop in US Treasury yields coupled with sustained elevation in inflation pressures (as measured by the 5- and 10-year breakeven rates) has kept US real yields pointed lower. As was the case through much of 2020, eroding US real yields served to weaken the greenback’s appeal relative to other major currencies, and more downside pressures in US real yields would likely imperil the US Dollar.
US Economic Calendar Looks Thin
With the May US nonfarm payrolls report and May US inflation report in the rearview mirror, there’s not much by way of data releases that could help change the narrative before or after the Fed’s meeting.
The middle of June offers a quieter economic calendar that the first two weeks of the month, and with measures of volatility across asset classes down across the board, outside of individual instances of event risk, there may not be much volatility in USD-pairs over the coming days:
- On Tuesday, June 15, the May US retail sales report will be released alongside the May US producer price index report. May US industrial production data are due, as are the April US business inventories figures and the June US NAHB housing market index.
- On Wednesday, June 16, May US building permits and housing starts data will be released. Later in the day, the Federal Reserve’s Federal Open Market Committee (FOMC) will conclude its June policy meeting, culminating in a press conference featuring Fed Chair Jerome Powell.
- On Thursday, June17, the weekly US jobless claims figures will be released ahead of the June US Philadelphia Fed manufacturing index.
Atlanta Fed GDPNow 2Q’21 Growth Estimate (June 11, 2021) (Chart 2)
Based on the data received thus far about 2Q’21, the Atlanta Fed GDPNow growth forecast has been slightly downgraded. “The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2021 is [+9.3%] on June 9, down from [+9.4%] on June 8. After this morning’s wholesale trade release from the U.S. Census Bureau, the nowcast of second-quarter real gross private domestic investment growth decreased from [+18.7%] to [+18.1%].”
The next update to the 2Q’21 Atlanta Fed GDPNow growth forecast is due on Tuesday, June 15 following the slew of US economic data set to be released over the course of the first half of US trading.
For full US economic data forecasts, view the DailyFX economic calendar.
Fed Stance Slowly Shifting? Not Towards Rates
The Federal Reserve has made clear that it will be keeping rates low and stimulus flowing for the foreseeable future. Setting aside the fact that interest rates hikes won’t rise soon, all focus is on the timing of when the Fed will taper its asset purchase program.
Accordingly, the June Federal Reserve meeting is likely to formally kickoff taper talk, insofar as policymakers will acknowledge that we’ve moved from ‘potentially talking about discussions about tapering’ to the actual ‘discussions about tapering.’
Federal Reserve Interest Rate Expectations (June 11, 2021) (Table 1)
Proving increasingly stable, Fed funds futures continue to discount an approximate 10% chance of a change in Fed rates each monththrough January 2022. Nevertheless, the liquidity drain continues thanks to record high reverse repo volumes across the Fed’s open markets desk. Without a corresponding rise in US Treasury yields, we’re effectively starting off on the course of a tantrumless taper.
There’s been a lot of conversation around the perceived timeline of the Federal Reserve’s plan to taper its asset purchases following the discouraging May US nonfarm payrolls report and the hot May US inflation report. Nevertheless, the it appears that market participants continue to have the taper timeline priced as such:
- June through September 2021 = taper talk
- September 2021 = indication taper is coming
- December 2021 = taper targets announced
- January 2022 = taper begins
- September/December 2022 = taper ends
- March 2023/June 2023 = first rate hike (3-6 months post-end of taper)
If you haven’t read the note, The Scary Fed Number Everyone is Talking About, you might be interested in doing so to get more context about where the Fed currently stands.
CFTC COT US Dollar Futures Positioning (June 2020 to June 2021) (Chart 3)
Finally, looking at positioning, according to the CFTC’s COT for the week ended June 8, speculators slightly increased their minor net-long US Dollar positions to 4,619 contracts, up from 4,259 contracts held in the week prior. US Dollar positioning has been hovering around fairly neutral levels for the past three months. Nevertheless, it remains a glaring example of US Dollar weakness that the last time the futures market was at similar positioning levels, the DXY Index was trading closer to 96.00.
— Written by Christopher Vecchio, CFA, Senior Currency Strategist