Fundamental Forecast for the US Dollar: Neutral

A dovish Federal Reserve and fresh multi-year highs in the Dow Jones Industrial Average sunk the US Dollar to new lows against the Euro and other key counterparts, leaving few hopes of a sustained USD recovery. Traders show little interest in low-yielding US Dollar positions, and indeed Commitment of Traders data showed Non-commercial traders at their most short USD since the Euro traded towards 1.60 in 2007. The US Dollar remains a speculator’s favorite with record-low interest rates and little risk of US Federal Reserve rate hikes through the foreseeable future. A busy week for US economic event risk and international central bank rate decisions could nonetheless shape market forecasts for future yield spreads and force major moves across key currency pairs.

Markets expect that Friday’s US Nonfarm Payrolls data will show the US added a net 200k jobs in April—roughly in line with March figures and reflective of modest growth in employment. Yet a very wide range of economist forecasts emphasizes that anything could happen, and any significant upward surprises could have similar effects on US FOMC rate expectations. US Dollar risks arguably remain to the upside ahead of the release. It’s difficult to envision a significant deterioration in Fed rate expectations on a disappointment, while above-forecast results could boost lackluster monetary policy expectations. Earlier-week ISM Manufacturing, ISM Services, and ADP Employment data should shape sentiment heading into the potentially critical Nonfarm payrolls report.

We will likewise look to European Central Bank, Bank of England, and Reserve Bank of Australia interest rate decisions to potentially shift interest rate expectations and spark larger moves across global financial markets. Overnight Index Swaps predict that the US Federal Reserve will raise interest rates by a paltry 31 basis points in the coming 12 months. ECB predictions stand at a relatively robust 75bps, and the prospect of widening rate differentials has without a doubt boosted the EURUSD through recent trade. All three banks are expected to leave rates unchanged, but markets will monitor post-announcement rhetoric from each the ECB, BoE, and RBA for clues on future decisions.

Sharp downward momentum and bearish market sentiment leave dollar risks to the downside through the coming week of price action. Yet steadily rising volatility expectations warn of tensions below the surface. As the third-lowest yielding major world currency, the US Dollar has become a favorite funding currency for the Global FX Carry Trade. If the Dow Jones and other key ‘risk’ barometers continue their seemingly unstoppable rallies, we might expect the US Dollar to move lower in kind. Yet traders should keep a close eye on ‘risk’ in a potentially pivotal week of price action. Heavily one-sided US Dollar short positions suggest that the Greenback could gain substantially on a deleveraging across global financial markets.

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