Dollar is Volatility Bound with FOMC, NFPs and Earnings…But Is There a Trend?

Fundamental Forecast for the US Dollar: Bullish

If there were a market that were better primed for a technical break over the coming week than the US Dollar, I am not aware of it. The activity levels for the Greenback these past two weeks has been extremely restricted, which is an extraordinary contrast to the dramatic slide the currency suffered through in its slide from multi-decade highs starting approximately four months ago. An accelerated reversal on a drawn-out bull run highlights the impact that speculation can have in amplifying price action when conviction hits its saturation point. While there is still plenty of potential for sentiment to swell behind a bullish or bearish view; from our present standing, it would likely need to come from a more concrete fundamental backdrop. From purely a statistical perspective, the likelihood of a technical break from the past two weeks’ range looks highly probable. Over the span of 11 trading days through Friday, the DYX Dollar Index has carved out its smallest range (1.37 percent) since February of last year – surpassing the quiet of the December holiday period. However, forging a breakdown doesn’t inherently mean a trend will follow. With a dense economic docket of top fundamental, market-moving indicators; volatility risk is high. Yet, a sequential release of this trend-capable data can also disrupt the market’s ability to formulate a clear path.

Chart of DXY Dollar Index with 50 and 100-Day SMAs, 11-Day Historical Range(Daily)

In the global economic calendar, there is plenty of event risk that carries the capacity to influence worldwide financial health – much less the US markets. However, it is likely that the US docket guides the global course. Filtering for just the major US event risk (and a couple global matters with heavy implications for the Dollar) below, it is easy to see the weight in the fundamental potential. Starting at the beginning of the week, we have the update from the IMF on the World Economic Outlook. This is an interim update on a report that is more ‘miss’ than ‘hit’ for satisfying the market’s view on growth forecasts and generating volatility. Nevertheless, this is a theme that we should keep a clear bead on given its profound implications for the global economy. There are a few more high-profile indicators with significant influence on the fundamental evaluation between the IMF and Wednesday afternoon’s FOMC rate decision (US consumer confidence and ISM manufacturing), but the pull of anticipation will likely prove difficult to override the curb on activity.

There is a lot of interpretation and competing expectations around the central bank’s rate decision, but the Dollar response that follows will tell us what way the markets are taking assessing. Depending on that assessment, Thursday afternoon’s FAANG earnings (Apple, Google and Amazon) could fuel speculation or growth theme. Friday’s NFPs release will also be of great interest for more than just its capacity for volatility. How we respond to the outcome – as a spark for rate speculation or the backdrop for economic health implications – will tell us a lot about our trajectory going forward.

Top US and Global Macro Event Risk Next Week

At the end of such a packed week, it is not clear to me what the guiding light will be for the markets fundamentally. Though we have seen the speculation around the Fed’s terminal rate and possibility for cuts in the second half of 2023 fuel bullish fever dreams up through recent weeks, the well of bullish enthusiasm that it seems to generate for risk assets seems to be flagging. Given the central bank’s stated stance, they are not in the form of responding to every ebb and flow behind market measures in a bid to feed marginal growth through tickle down economics as they once were. A relent on the inflation fight would either need to come from a sudden collapse in price pressures to suggest deflation is a risk – or the country would need to face a significant economic crisis. Neither would be particularly favorable for US health, but it could restore the Dollar’s safe haven status. Bullish or bearish, the relationship of the Greenback to implied rate forecasts (through Fed Fund futures) and risk trends (via the VIX) suggests that there is a slight advantage to the latter theme. And, as we know from volatility, fear is the stronger emotion.

Chart of DXY Dollar Index Overlaid with the VIX Volatility Index (Daily)

For most of the Dollar-based majors, the fundamental considerations tend to align to a fairly uniform perspective. EURUSD, GBPUSD and AUDUSD for example all seem to align to the same circumstances regardless of whether we are discussing growth forecast, risk trends or carry appetite. That said, I believe that there is some distinct refinement to USDJPY. From the carry trade perspective, the Bank of Japan does not seem as if it will be closing the gap with the Fed’s benchmark rate anytime soon. Therefore, a plateau in the US benchmark will generate less response here compared to a pair where the counter-currency contributes a perspective (such as the ECB with EURUSD). As for the ‘risk’ perspective, there is the carry trade consideration behind the Yen crosses and the epic rise in interest rates this past year. That said, how much over-extended premium is there to this pair after retracing half of its nearly two-year climb in the span of just a few short months? In this case, the more severe interpretation of a safety that usually conforms to the Greenback seems the more noteworthy sway.

Chart of USDJPY with 50 and 100-Day SMAs, Spot to 20-Day Differential Index (Weekly)

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