Fundamental Forecast for the US Dollar: Neutral

The US dollar saw its smallest weekly trading range against the Euro since July 2007, underlining market indecision as the Greenback trades near significant lows against a broad range of major counterparts. Broader financial market ‘risk’ trades have likewise reached what seems to be an impasse; the Dow Jones Industrial Average continues to consolidate after setting fresh multi-year peaks set through early-month trade. A relatively quiet week of US economic event risk suggests that the Greenback could remain within a tight range against the euro, but any significant moves in ‘risk’ could quite easily push the dollar in either direction through upcoming trade.

CFTC Commitment of Traders data shows speculative US Dollar futures positioning at its most bearish since 2007, and deleveraging across financial markets could easily bring the long-awaited Greenback reversal. Yet speculative positioning has remained at extremes for quite some time now as the Greenback continues to decline against the Euro and other key counterparts. Financial markets could see noteworthy volatility on significant surprises in the coming week’s US housing data. The lack of any top-tier economic releases nonetheless leaves little foreseeable justification for a substantial US Dollar breakout in either direction.

The S&P 500 Volatility Index (VIX) trades near its lowest levels since the onset of the global financial crisis in late 2007, and the US Dollar is unlikely to rally given such clear financial market complacency. FX Options markets volatility expectations likewise shows exceedingly low volatility expectations, inviting traders to take advantage of low-vol trading strategies.

The most attractive strategy in current conditions is arguably the FX Carry Trade—borrowing low-yielding currencies in order to buy their higher-yielding counterparts. According to Bloomberg calculations, the benchmark G10 carry trade portfolio recently hit fresh record highs—surpassing the peaks seen through 2007. The astounding Carry Trade losses through the height of the financial crisis suggested it could be many years before said portfolio could set a new high. Yet robust risk appetite and low financial market volatility have allowed the risky trading system to do quite well through recent market conditions.

As the second-lowest yielding currency in the industrialized world, the downtrodden US Dollar remains a primary candidate for low-interest borrowing and subsequent bets in higher-yielding assets. Said dynamic explains why FX market correlations to the Dow and S&P trade near record-strength. Trader attention remains squarely on developments in broader ‘risk’, and we will likely need to see a substantive sell-off in the Dow Jones before the US Dollar sees any real comeback against the Euro and other major counterparts. Alternatively, the US Dollar could bounce on an important shift in US Federal Reserve interest rate expectations. Given recent Fed rhetoric, however, we put relatively low odds on such an important shift through the foreseeable future.

DailyFX provides forex news on the economic reports and political events that influence the forex market.