Fundamental Forecast for the US Dollar: Neutral
- The US Dollar (via the DXY Index) has moved up to fresh yearly highs as traders have begun to anticipate a faster-than-expected timeline to the Federal Reserve’s stimulus withdrawal.
- Fed Chair Jerome Powell’s speech at Jackson Hole is vaguely titled “The Economic Outlook,” and is set to take place on Friday, August 27 at 10 EDT/14 GMT.
- According to the IG Client Sentiment Index, the US Dollar has a mixed bias heading into the last week of August.
US Dollar Sets New Highs
The US Dollar (via the DXY Index) added +1.01% last week, moving up to fresh yearly highs as traders have begun to anticipate a faster-than-expected timeline to the Federal Reserve’s stimulus withdrawal. The largest component of the DXY Index, EUR/USD rates, dropped by -0.81% and closed below 1.1700 for the first time since October 2020. USD/JPY rates gained +0.16%, hampered by weakness in equity markets.
But gains for the US Dollar were flush across the board otherwise as escalating delta variant concerns sapped confidence in global growth-sensitive currencies: GBP/USD fell -1.76%; AUD/USD dropped -3.13%; NZD / USD sank -2.94%; and USD / CAD added +2.47%.
US Economic Calendar Not Waiting on Jackson Hole
The end of August will produce a busy docket of event risk based out of the US. Over the course of the week into of the Jackson Hole Economic Policy Symposium, there are five ‘high’ rated events that hold promise to bring about significant event risk-based volatility.
- On Monday, August 23, the JulyChicago Fed national activity index, the August US Markit manufacturing PMI (flash), and the July US existing home sales data are due.
- On Tuesday, August 24, the July US new home sales report will be released.
- On Wednesday, August 25, the July US durable goods orders report is set for publication.
- On Thursday, August 26, the Jackson Hole Economic Policy Symposium will begin. The second release of the 2Q’21 US GDP report is due, as are weekly jobless claims figures.
- On Friday, August 27, the July US PCE report (the Fed’s preferred gauge of inflation) will be released, as will the August US Michigan consumer sentiment reading. At 10 EDT/14 GMT, Fed Chair Powell will deliver his Jackson Hole speech, vaguely titled “The Economic Outlook.”
Atlanta Fed GDPNow 3Q’21 Growth Estimate (August 18, 2021) (Chart 1)
Based on the data received thus far about 3Q’21, the Atlanta Fed GDPNow growth forecast has been downgraded from +6.2% to +6.1% annualized. After the past week’s data, “the nowcast of third-quarter real residential investment growth decreased from 3.4 percent to 3.0 percent.”
The next update to the 3Q’21 Atlanta Fed GDPNow growth forecast is due on Wednesday, August 25.
For full US economic data forecasts, view the DailyFX economic calendar.
All Eyes (and Ears) on Fed Chair Powell
If only to highlight how far delta variant concerns have come in recent weeks, the Jackson Hole Economic Policy Symposium has shifted from in-person to a virtual event this coming week. The event, titled “Macroeconomic Policy in an Uneven Economy,” is likely to stir volatility in financial markets at the end of the week and the start of the next.
Fed Chair Jerome Powell’s speech at Jackson Hole is vaguely titled “The Economic Outlook,” and is set to take place on Friday, August 27 at 10 EDT/14 GMT. The mysterious title will only incentivize Fed watchers to look for more clues that a Fed taper is nearing, insofar as the reaction to the July FOMC minutes has proved consistent with the historical precedent establish around the 2013/2014 taper timeline.
Bond Market Expecting a Hawkish Powell
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 1 below showcases the difference in borrowing costs – the spread – for the September 2021 and December 2023 contracts, in order to gauge where interest rates are headed in the interim period between September 2021 and December 2023.
Eurodollar Futures Contract Spread (September 2021-December 2023) versus US 2s5s10s Butterfly: Daily Rate Chart (August 2020 to August 2021) (Chart2)
We can overlay Fed rate hike odds with the US Treasury 2s5s10s butterfly in order to gauge whether or not the bond market is acting in a manner similar to what occurred in 2013/2014 when the Fed began to move forward with its taper plans. 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.
Indeed, while Fed rate hike odds were largely unmoved after the July FOMC minutes – which clearly stated the delineating between tapering and rate hikes – we can see that the US yield curve is moving in a manner that suggests a more hawkish Fed is here. While there are 87-bps of rate hikes discounted through the end of 2023, the 2s5s10s butterfly increased to its highest rate since the Fed taper talk began in June.
US Treasury Yield Curve (1-year to 30-years) (August 2019 to August 2021) (Chart 3)
Historically speaking, the combined impact of rising US Treasury yields – particularly as intermediate rates outpace short-end and long-end rates – alongside elevated Fed rate hike odds has produced a more favorable trading environment for the US Dollar.
CFTC COT US Dollar Futures Positioning (August 2020 to August 2021) (Chart 4)
Finally, looking at positioning, according to the CFTC’s COT for the week ended August 3, speculators increased their net-long US Dollar positions to 19,206 contracts from 18,880 contracts. Net-long US Dollar positioning is holding near its highest level since the second week of March 2020 (the apex of coronavirus pandemic concerns in financial markets).
— Written by Christopher Vecchio, CFA, Senior Currency Strategist