Fundamental Outlook for US Dollar: Bullish

- Even the IMF pegs the US dollar as the top funding currency for a market hungry for yield
- A sharp jump in the trade deficit and drop in consumer confidence contradict an outlook for recovery
- The US dollar has held its low; but can the greenback finally reverse course or will it once again collapse?

The dollar was able to manage its most aggressive rally against its chief counterpart (the euro) in months this past week; but the move would not last. Without a scheduled or unscheduled event to dramatically alter the dollar’s status in the well-worn carry trade, risk appetite would ensure the currency would remain shackled to its eight-month old bearish trend channel. Looking out over the week to come, the most pressing question for any trader is determining if and when the greenback will finally catalyze its next trend. Some may argue that direction is the primary concern; but without momentum and follow through, the result is fundamental chop that leaves the market open to volatility while slowly building up the pressure behind the eventual breakout. So, is there potential for a clear, dollar trend in the week ahead?

While there are a few notable economic indicators scheduled for release over the coming days, the experienced fundamental trader knows there is a low probability that any one (or very likely all of data working in conjunction) could actually leverage such a meaningful change of trend. These indicators’ principal value is in establishing the forecasted pace of economic recovery and, to a lesser extent, offering minor adjustments to the Fed’s time frame for a return to a hawkish policy regime. However, those following the dollar know that the asset’s primary role is as the safe haven and funding currency for the broader market. Therefore, the analysis on this single currency’s future turns into an assessment of overall risk appetite through the global financial markets. Taking a more expansive look at sentiment, there seem to be few scheduled events or indicators that can spark fear or greed all on its own. In fact, the quality of the data is all-in-all relatively reserved. Somewhat counter-intuitively, these may be the ideal conditions to reestablish a true bias. Often times, when there is a major market-moving event due; price action leading up to its release is muted as traders do not want to leverage risk by increasing exposure. What’s more, if the news doesn’t fall far from forecasts or it otherwise doesn’t play into the larger market themes; a modest increase in volatility is all it can rouse. More often than not, it is those times when the docket is otherwise unencumbered that we see sentiment build momentum and define new trends.

Through the coming weeks and months there is little doubt that risk appetite will define the dollar’s future. However, eventually this negative correlation will eventually fade. To break from the all-consuming fundamental current, the greenback will need to shed its role of the market’s safe haven and funding currency (depending on whether optimism or pessimism is the primary temperament at any time). Altering this brand will be difficult; but a shift in interest rates (target and market) and/or the fiscal health of the US can do it. Currently, the benchmark market rate, the three-month Libor, is at a discount to its Japanese counterpart (history’s favored carry trade component) at 0.2725 percent. A major shift in capital flows into the US or an accelerated timeline for Fed rate hikes can change this. To increase the tepid probabilities of a near-term rate hike (there is a mere 5.7 percent chance for January 27th and only 44 percent probability for June 23rd according to Fed Fund futures), we will take note of the week’s economic offerings. Retail sales will serve as a barometer for consumer spending (accounting for approximately three-quarters of GDP) and the October CPI numbers will reveal whether there is any merit to hawkish concerns through fears of looming inflation.

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