Fundamental Forecast for Dollar: Bullish

A slew of Fed speeches and November NFPs will pilot rate expectations that already see a 78% chance of a Dec hike. The greater fundamentals winds may come from the Dollar’s peers amid a round of rate decisions and SDR status checks

The week ahead is the antithesis of what we have come to expect from December. Seasonal studies say the month is historically a quiet one with a quiet build in risk appetite. Instead, we are heading into the first wave of a significant fundamental assault that will test already flimsy speculative forecasts while running a high risk of volatility. The question immediately on most FX traders’ minds is whether the standings of monetary policy biases shaped over the past few months will hold their course. Yet, participants of all markets should be more concerned over the implications of volatility against thin volume and a leveraged speculative exposure. These are circumstances ripe for liquidity problems and a dramatic shift in both market direction and pace.

It is natural for traders confronted with a wide docket of event risk and fundamental uncertainty to hone in on what they perceive to be the most market-moving potential spark and set their strategy and expectations from there. That would be a mistake if we were trading the Dollar this week. The favored indicator on the calendar ahead is the November NFPs (nonfarm payrolls) and its supporting cast of labor statistics. This data is certainly important. Relative monetary policy has been one of the most productive and constant fundamental themes in the currency market. NFPs is the last major statistic with a direct bead on policy that is scheduled to be released before the December 16 rate decision.

That said, the market is already well-prepared for the disparate bearing from the US currency. Where six weeks ago, Fed Fund futures were pricing in around 6 percent probability of a Fed hike before the end of the year; now same instrument shows hedgers set the chances at 78 percent. Where that leaves plenty of room to lift or lower the stakes, the reality is that the Fed – and thereby the Dollar – is in a unique position to tighten in a definable timeline where most other are proactively easing or neutral. In the data breakdown, the actual payrolls and unemployment rate will carry less weight than the participation and average earnings figures. Wages in particular will be meaningful as it reflects the missing piece of the monetary policy puzzle: inflation.

If the Dollar is to find its next leg higher or meaningfully lose ground to its counterparts, the true focus will turn to the ‘pace’ from the FOMC. Where this has been a common warning by policy officials for months, most speculators have obsesses over the timing of the first hike (likely making them eager to get it out of the way). Yet, after ‘liftoff’, projecting the second, third, fourth and so on increases will be more important for developing extended values. A number of Fed member discussions scheduled this week will likely help shape that forecast. Chairwoman Janet Yellen is set to testify between the Joint Economic Committee in Congress; but I’m more interested in Fed Brainard’s speech on neutral rates, Mester and Fischer’s talks on financial stability, Bullard’s remarks on the ‘new normal’ and Kocherlakota’s views on ‘renormalization’.

Reminding us that there are deeper currents to the market than just the Fed’s first move to normalize reminds us that eventually monetary policy will shift across the world. And, that time may be closer than investors are prepared for especially with the exceptional amount of risk they are balancing. That risk and the imminence of a retracted global central bank safety net will also bubble to the surface with other, major global event risk. Policy decisions by the ECB, RBA, BoC and RBI; GDP updates in the developed and developing world; and China’s SDR status are just a few major events that can give indirect USD influence and change the global financial system’s current.