Weekly Fundamental US Dollar Forecast: Rate Hike Odds Buoy the Buck

FUNDAMENTAL FORECAST FOR THE US DOLLAR: NEUTRAL

• US Treasury rates have continued to increase in response to the fast increasing likelihood of a Fed rate hike, which has bolstered the strength of the US Dollar.
• The March nonfarm payrolls data, which will be released on Friday, may be overshadowed by the continuous comments from Federal Reserve officials, who have indicated that a 50 basis point rate rise would be implemented at their next meeting.
• As indicated by the IG Client Sentiment Index, the US Dollar is expected to have a mixed bias moving into the last week of the month.

US DOLLAR WEEK IN REVIEW

The US Dollar recovered from a weak performance in mid-March, finishing last week up by +0.59 percent, marking the currency's sixth weekly gain in the preceding seven weeks on a cumulative basis. A more difficult tale is being hidden behind the headline gain: the US Dollar lost territory versus the majority of currencies last week. GBP/USD rates were up by 0.03 percent, while USD/CHF rates were down by 0.13 percent, and USD/CAD rates were down by -1.02 percent for the week. Instead, the EUR/USD and USD/JPY rates did the most of the heavy lifting, with the former dropping -0.62 percent and the latter gaining an astonishing +2.47 percent.

US ECONOMIC CALENDAR IN FOCUS

As has been the case for the most of the last month, economic data from the United States has had no meaningful role in the US Dollar's recent successes or failures. Because the Federal Reserve has been 'foaming the runway' for a 50-basis-point rate rise when it meets next in May, markets are paying greater attention to what officials are saying until then. This has effectively rendered the impact of data releases until then almost non-existent. Furthermore, increasing commodity prices and interbank market financing pressures as a consequence of Russia's invasion of Ukraine and the accompanying sanctions imposed by the European Union and the United States continue to have major influence on 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)

With data collected thus far for 1Q'22, the Atlanta Fed GDPNow growth projection is currently +0.9 percent annualized, a decrease from the previous forecast, which was +1.3 percent annualized on March 17. The reduction was caused by "real gross private domestic investment growth [decreasing] from -4.2 percent to -5.8 percent," according to the report.

The next update to the Atlanta Fed GDPNow growth prediction for the first quarter of 2012 will be released on Thursday, March 31 after the release of the February US personal income and expenditure data.

FED TURNS UP HAWKISH RHETORIC

Fed Chair Jerome Powell's series of hawkish comments over the past week has dramatically increased expectations that not only will the FOMC raise rates by 50 basis points when they meet next in May, but that the FOMC will embark on an even more aggressive monetary tightening campaign in the coming months.

By comparing the difference in borrowing rates for commercial banks over a given time horizon in the future, we may determine if a Fed rate rise is being priced in using Eurodollar futures. The gap between borrowing costs for the March 2022 and December 2023 contracts is shown in Chart 2 below, which may be used to determine where interest rates will be in December 2023. The spread is the difference between borrowing costs for the March 2022 and December 2023 contracts.

EURODOLLAR FUTURES CONTRACT SPREAD (MARCH 2022-DECEMBER 2023) [BLUE], US 2S5S10S BUTTERFLY [ORANGE], DXY INDEX [RED]: DAILY TIMEFRAME (MARCH 2021 TO MARCH 2022) (CHART2)

By comparing Fed rate hike chances with the US Treasury 2s5s10s butterfly, we can determine whether or whether the bond market is behaving in a way comparable with what happened in 2013/2014, when the Fed announced its plan to reduce its quantitative easing program, or quantitative easing (QE). According to historical data, the butterfly gauges non-parallel movements in the yield curve in the United States. This indicates that intermediate rates should climb more quickly than short- or long-end rates, assuming that history is right.

There are now eighteen 25 basis point rate increases discounted until the end of 2023. Rates markets are pricing in a 78 percent possibility of nine 25-basis-point rate rises through the end of the calendar year 2019. During the same time period, the 2s5s10s butterfly has spread significantly in recent weeks. In conjunction with one another, these factors point to a persistent strengthening of the US Dollar, especially versus lower yielding peers such as the Euro and the Japanese Yen.

US TREASURY YIELD CURVE (1-YEAR TO 30-YEARS) (MARCH 2020 TO MARCH 2022) (CHART 3)

The expansion of the 2s5s10s butterfly pattern, together with increasing US Treasury rates, is contributing to the strengthening of the US Dollar. The continued rise in inflation expectations in the United States (as measured by the 2y2y and 5y5y inflation swap forwards), combined with evidence of persistent liquidity stresses, suggests that the US Dollar will remain resilient, regardless of what happens on the economic calendar in the coming months. As a result, bond prices continue to rise on expectations that the Fed would hike rates not just for multiple meetings in a row, but also in 50-basis-point increments going forward.

CFTC COT US DOLLAR FUTURES POSITIONING (MARCH 2020 TO MARCH 2022) (CHART 4)

Looking at posture, the CFTC's COT for the week ending March 22 shows that traders boosted their net-long US Dollar holdings to 29,597 contracts from 28,345 contracts, reflecting an increase in net-long US Dollar positions. The net-long position in the US Dollar has recovered from its lowest point since the first week of October 2021, but it is still -24 percent below its year-to-date peak.