US Dollar: FOMC Could Drive Volatility, but Watch the S&P 500
Fundamental Forecast for the US Dollar: Neutral
- US Dollar sinks against all major counterparts on rally in ‘risk’
- Chinese rate hike fears could drive risk-aversion and US Dollar strength
- View our monthly Euro/US Dollar Exchange Rate Forecast
The US Dollar rallied against almost all G10 currencies despite a strong week for ‘risk’ as the S&P 500 closed at fresh multi-year highs through Friday’s close. Correlations between key asset classes broke down in a week where we saw equities and bonds rally and fall at the same time, and the safe-haven US Dollar squeezed out gains despite ostensibly adverse conditions. Attention now turns to the coming week of potentially market-moving event risk, with the US Federal Open Market Committee decision and inflation data likely to cause ripples across global financial markets in the week ahead.
Markets very widely expect that the US Federal Reserve will leave monetary policy exactly unchanged through their upcoming decision, but it will be equally important to monitor for any shifts—no matter how subtle—in official rhetoric. The subsequent days of Consumer and Producer Price Index inflation data will likewise taken on renewed importance as the Fed embarks on controversial Quantitative Easing policies. Given that equity markets and financial companies have generally benefited from the highly accommodative monetary policy, the clear risk is that rising inflation would force the Fed to pull back measures to boost the economy. Likewise significant, recent fears on the future of US Government deficits have led to substantial rallies in US Treasury bond yields—thereby offsetting much of the effects of Quantitative Easing and tightening monetary conditions.
As we close in on the end of the year, it is easy to see that it has been a strong second-half performance for equity markets and a continuation in the secular downtrend for the US Dollar. Yet we maintain that the US Dollar is on pace for further recovery against the Euro and other key counterparts through the shorter-term. Whether this plays out through the final weeks of the year will almost certainly depend on whether stocks continue their recent torrid pace. Yet semi-frequent sharp declines in equities warn that risk sentiment remains fragile, and one gets the sense that any number of catalysts could spark renewed sell-offs in the S&P and other key asset classes. In the short term, watch market reactions around the FOMC result and a steady stream of US economic event risk. – DR
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