Fundamental Forecast for the US Dollar: Neutral
- US Treasury yields continue to rise in accordance with rapidly escalating Fed rate hike odds, underpinning US Dollar strength.
- The March US nonfarm payrolls report on Friday may be dwarfed by the ongoing commentary from Federal Reserve policymakers that a 50-bps rate hike is coming at their next meeting.
- According to the IG Client Sentiment Index, the US Dollar has a mixed bias heading into the last week of March.
US Dollar Week in Review
The US Dollar shrugged off a poor performance in mid-March, closing last week higher by +0.59%, its sixth weekly gain over the past seven weeks overall. But the headline gain masks a more complicated story: the US Dollar lost ground against most currencies last week. GBP/USD rates were up by +0.03%, USD/CHF rates lost -0.13%, and USD/CAD rates dropped by -1.02%. Instead, the heavy lifting was done by EUR/USD and USD/JPY rates, with the former losing -0.62% and the latter adding an impressive +2.47%.
US Economic Calendar in Focus
Like for most of the past month, it remains the case that US economic data are not a significant factor in the US Dollar’s recent success or failures. Markets are paying more attention to what Federal Reserve policymakers are saying, insofar as they’ve been ‘foaming the runway’ for a 50-bps rate hike when they meet next in May, more or less neutering the importance of data releases until then. Moreover, higher commodity prices and interbank market funding stresses resulting from Russia’s invasion of Ukraine and the ensuing sanctions by the European Union and the United States retain significant sway over market conditions.
With that said, here’s the US economic data due out in the coming days:
- On Monday, March 28, the February US goods trade balance and the February US retail inventories (ex-autos) will be released at 12:30 GMT.
- On Tuesday, March 29, the January US house price index will be published at 13 GMT, followed by a speech by New York Fed President John Williams. March US consumer confidence figures will be in focus at 14 GMT.
- On Wednesday, March 30, weekly US mortgage applications figures will be released at 11 GMT followed by the March US ADP employment change report at 12:15 GMT. Shortly thereafter, the final 4Q’21 US GDP report will be published.
- On Thursday, March 31, a plethora of data releases are due out at 12:30 GMT: the February US PCE report; weekly US jobless claims; February US personal income figures; and February US personal spending figures. At 13 GMT, New York Fed President Williams will give remarks.
- On Friday, April 1, the March US nonfarm payrolls report will be published at 12:30 GMT, as will the March US unemployment rate. The March US ISM manufacturing PMI and February US construction spending data will be released at 14 GMT.
Atlanta Fed GDPNow 1Q’22 Growth Estimate (March 24, 2021) (Chart 1)
Based on the data received thus far about 1Q’22, the Atlanta Fed GDPNow growth forecast is now at +0.9% annualized, down from +1.3% on March 17. The downgrade was a result of “real gross private domestic investment growth [decreasing] from -4.2% to -5.8%.”
The next update to the 1Q’22 Atlanta Fed GDPNow growth forecast is due on Thursday, March 31 after the February US personal income and spending data.
For full US economic data forecasts, view the DailyFX economic calendar.
Fed Turns Up Hawkish Rhetoric
A slew of hawkish comments over the past week, led by Fed Chair Jerome Powell himself, have dramatically escalated expectations that not only will the FOMC raises rates by 50-bps when they meet next in May, but will constitute an even more aggressive monetary tightening effort over the coming months.
We can measure whether a Fed rate hike is being priced-in using Eurodollar contracts by examining the difference in borrowing costs for commercial banks over a specific time horizon in the future. Chart 2 below showcases the difference in borrowing costs – the spread – for the March 2022 and December 2023 contracts, in order to gauge where interest rates are headed by December 2023.
Eurodollar Futures Contract Spread (March 2022-December 2023) [BLUE], US 2s5s10s Butterfly [ORANGE], DXY Index [RED]: Daily Timeframe (March 2021 to March 2022) (Chart1)
By comparing Fed rate hike odds with the US Treasury 2s5s10s butterfly, we can gauge whether or not the bond market is acting in a manner consistent with what occurred in 2013/2014 when the Fed signaled its intention to taper its QE program. The 2s5s10s butterfly measures non-parallel shifts in the US yield curve, and if history is accurate, this means that intermediate rates should rise faster than short-end or long-end rates.
There are now eight25-bps rate hikes discounted through the end of 2023. Rates markets are discounting a78% chance of nine 25-bps rate hikes through the end of next year. Concurrently, the 2s5s10s butterfly has widened sharply in recent weeks. Both of these developments are consistent with sustained US Dollar strength, particularly against lower yielding counterparts like the Euro and the Japanese Yen.
US Treasury Yield Curve (1-year to 30-years) (March 2020 to March 2022) (Chart 3)
The widening of the 2s5s10s butterfly coupled with rising US Treasury yields is helping reinforce US Dollar strength. The ongoing rise in US inflation expectations (as measured by the 2y2y and 5y5y inflation swap forwards) coupled with evidence of liquidity stresses persisting suggest that the US Dollar will remain resilient, regardless of what’s happening on the economic calendar. Bonds continue to trade as if the Fed will raise rates for not just several meetings in a row, but also in 50-bps increments.
CFTC COT US Dollar Futures Positioning (March 2020 to March 2022) (Chart 4)
Finally, looking at positioning, according to the CFTC’s COT for the week ended March 22, speculators increased their net-long US Dollar positions to 29,597 contracts from 28,345 contracts. Net-long US Dollar positioning has rebounded from its lowest level since the first week of October 2021, but remains -24% below its high of this year.
— Written by Christopher Vecchio, CFA, Senior Strategist