USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Fed turned a lot more hawkish than expected in Dec. They doubled the pace of tapering to $30 billion per month which will see QE concluded by March 2022 as was widely expected. Surprisingly though the Summary of Econ Projections showed the median dot plot pencilled in 3 hikes for 2022 (up from the previous 1), confirming Fed Fund Future expectations. Fed Chair Powell explained they hadn’t decided whether to pause between the end of tapering and a first hike but reiterated that rates will likely only rise when QE has concluded. Another positive shift was Powell’s comments that they could raise rates before full employment has been met due to high inflation, and stated that with inflation above target, they cannot wait too long to get to maximum employment as current inflation levels is seen as a threat to max employment. The hawkish tilt went further to note that the bank started discussing the balance sheet but said no decisions were made on when QT might commence. Even though the dots projected 3 hikes for 2022, the updated rate trajectory only showed 1 additional hike over the forecast horizon, which combined with a lower terminal rate was less hawkish than some had feared. Nonetheless, the meeting marked a material hawkish shift from the Fed, putting it on par with the likes of the RBNZ. The meeting minutes also revealed that the QT discussion saw majority of members thinking it appropriate to start QT soon after rate lift off and another more hawkish tilt than expected from the Fed.
2. Global Risk Outlook
The growth & inflation outlook will be key for the USD, not only growth and inflation in the US but also global. The USD is often inversely correlated to global growth & inflation, doing bad during reflationary environments (growth and inflation accelerating), while the USD usually does well in disinflationary environments (growth and inflation decelerating). Thus, with expectations that both growth and inflation will decelerate this year, both in the US and the globe, that should be a positive input for the USD in the med-term. However, it also means there will be a lot of focus on the incoming data to see how it develops and how the Fed responds to it. For example, if the economic outlook worsens materially, the Fed could backtrack on their current aggressive path, which could mean downside for the USD if money markets start pricing out hikes, so incoming data is key.
3. CFTC Analysis
Latest CFTC data showed a positioning change of -1186 with a net non-commercial position of +37892. The shortterm unwinding of stretched USD longs played out exactly as expected. Even though the CFTC data does not show a big unwind we need to remember the big downside move in the USD started on Wednesday, which means last week’s COT data will not include any of that, so take this week’s data with a pinch of salt. With the fundamental bias unchanged, the real question is whether the flush we saw this past week is over.
4. The Week Ahead
In the week ahead, things will be very quiet on the data front for the US, with US participants also away on Monday for a bank holiday. Thus, a lot of the Dollar’s flow will be dictated by overall risk sentiment, key events for other major currencies, and of course focus on whether the bond and equity market continue to provide mixed signals on the growth and inflation outlook in the midst of the Fed’s current aggressive policy path. With markets pricing in well over 3 hikes for the Fed this year already, there is arguably still a lot of disappointment for money markets on this front if the economic picture starts to rapidly deteriorate. Even though that could add pressure to the USD as positioning gets squared up, keep in mind that a disinflationary environment is also usually USD positive, which means the path in the very short-term for the USD is less clear than we would have hoped it to be. In the week ahead the key technical levels to watch is key support between 94.70 and 94.50. We spoke about the importance of these levels a couple of times this past week and saw a solid bounce from that zone on Friday. A continuation of that bounce arguably opens up a retest of previous key support around 95.60, however if we push lower and take out key support it opens up for a move towards 93.40, so we are at a very important juncture right now from a technical and momentum perspective.
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Fed turned a lot more hawkish than expected in Dec. They doubled the pace of tapering to $30 billion per month which will see QE concluded by March 2022 as was widely expected. Surprisingly though the Summary of Econ Projections showed the median dot plot pencilled in 3 hikes for 2022 (up from the previous 1), confirming Fed Fund Future expectations. Fed Chair Powell explained they hadn’t decided whether to pause between the end of tapering and a first hike but reiterated that rates will likely only rise when QE has concluded. Another positive shift was Powell’s comments that they could raise rates before full employment has been met due to high inflation, and stated that with inflation above target, they cannot wait too long to get to maximum employment as current inflation levels is seen as a threat to max employment. The hawkish tilt went further to note that the bank started discussing the balance sheet but said no decisions were made on when QT might commence. Even though the dots projected 3 hikes for 2022, the updated rate trajectory only showed 1 additional hike over the forecast horizon, which combined with a lower terminal rate was less hawkish than some had feared. Nonetheless, the meeting marked a material hawkish shift from the Fed, putting it on par with the likes of the RBNZ. The meeting minutes also revealed that the QT discussion saw majority of members thinking it appropriate to start QT soon after rate lift off and another more hawkish tilt than expected from the Fed.
2. Global Risk Outlook
The growth & inflation outlook will be key for the USD, not only growth and inflation in the US but also global. The USD is often inversely correlated to global growth & inflation, doing bad during reflationary environments (growth and inflation accelerating), while the USD usually does well in disinflationary environments (growth and inflation decelerating). Thus, with expectations that both growth and inflation will decelerate this year, both in the US and the globe, that should be a positive input for the USD in the med-term. However, it also means there will be a lot of focus on the incoming data to see how it develops and how the Fed responds to it. For example, if the economic outlook worsens materially, the Fed could backtrack on their current aggressive path, which could mean downside for the USD if money markets start pricing out hikes, so incoming data is key.
3. CFTC Analysis
Latest CFTC data showed a positioning change of -1186 with a net non-commercial position of +37892. The shortterm unwinding of stretched USD longs played out exactly as expected. Even though the CFTC data does not show a big unwind we need to remember the big downside move in the USD started on Wednesday, which means last week’s COT data will not include any of that, so take this week’s data with a pinch of salt. With the fundamental bias unchanged, the real question is whether the flush we saw this past week is over.
4. The Week Ahead
In the week ahead, things will be very quiet on the data front for the US, with US participants also away on Monday for a bank holiday. Thus, a lot of the Dollar’s flow will be dictated by overall risk sentiment, key events for other major currencies, and of course focus on whether the bond and equity market continue to provide mixed signals on the growth and inflation outlook in the midst of the Fed’s current aggressive policy path. With markets pricing in well over 3 hikes for the Fed this year already, there is arguably still a lot of disappointment for money markets on this front if the economic picture starts to rapidly deteriorate. Even though that could add pressure to the USD as positioning gets squared up, keep in mind that a disinflationary environment is also usually USD positive, which means the path in the very short-term for the USD is less clear than we would have hoped it to be. In the week ahead the key technical levels to watch is key support between 94.70 and 94.50. We spoke about the importance of these levels a couple of times this past week and saw a solid bounce from that zone on Friday. A continuation of that bounce arguably opens up a retest of previous key support around 95.60, however if we push lower and take out key support it opens up for a move towards 93.40, so we are at a very important juncture right now from a technical and momentum perspective.