USD fundamental buoyancy seen deflating

Swiss International Financial Brokerage Co

The US Dollar has struggled for trend recently; and given the fundamental and market conditions backdrop, that is unlikely to improve in the coming week. For the Greenback’s own landscape, rate speculation has been materially crippled by the combination of the FOMC’s downgrade to its rate forecasts and Chairwoman Janet Yellen’s cautious tone on her outlook these past weeks. This will not prevent scheduled event risk from arising in the market, but it will lower its capability for generating a Dollar response. Meanwhile, broader volatility measures have significantly deflated from their remarkable levels at the beginning of the year. That temper speculators’ activities and certainly make the currency’s return to its haven status that much more difficult to inspire.

Monetary policy has both represented to the Dollar’s most prominent catalyst these past years and also its biggest disappointment in recently. When the cloud of accommodative monetary policy finally lifted and the market started to speculate on the eventual first rate hike from the Federal Reserve, the currency responded with an impressive climb. Not only did this set the stage for forecasts of higher returns on US assets, it was perceived as a signal of confidence that the US economy was on a materially stronger footing than its global counterparts. The realization of this slow move back into normalization, however, has not lived up to the hype.

In contrast to the first hike from the FOMC in December, forecasts for the pace of successive moves has quickly faded. Industrious fundamentalists have recognized the shift and what it means for the Dollar’s lift. However, it is important not to carry the correlation too far. A hawkish deviation carried substantial weight in a world still pursuing further easing measures – and hence the Dollar’s gains. Yet, eating away those premiums doesn’t present that same step-for-step response from the currency. While the fundamental buoyancy is certainly deflating, it doesn’t reverse the standings of a ‘hawkish’ Dollar to a ‘dovish’ Euro, Yuan, Yen, etc.

A currency that has seen its fundamental drive evaporate while the state of its counterparts restrain its subsequent bearish progress is in turn much more difficult to motivate to trend. In the week ahead, big-picture catalysts that could fundamentally upend the Dollar’s unique standings on the competitive monetary policy scale are few. Traditional data is of secondary quality (ISM services, economic surveys, etc) and there are a range of Fed member speeches scheduled. The most headline-worthy item on the list is a scheduled panel discussion with current Fed Chairwoman Janet Yellen and former heads of the bank Bernanke, Greenspan and Volcker. It is not unlikely we hear remarks on what they each believe is the best path forward – and I wouldn’t expect consensus from this cast.

Perhaps monetary policy can be supplanted by the motivation of sentiment. Volatility measures across financial assets have dropped significantly these past months, but there is concern in broad FX activity measures. The Dollar maintains a dormant safe haven quality that we haven’t seen stimulated in some time – because fear has yet to hit the intensity necessary to override the appeal of the currency’s tepid yield outlook. In current markets, we are not far from a liquidity-bred contagion issue; but fuses with the proper degree of influence have not shown themselves. Perhaps the masses will finally heed the warnings issued by the IMF. This week the group will release its Global Financial Stability Report and World Economic Outlook. Expect to reduced growth forecasts, lament over the efficacy of extreme monetary policy and another China and EM warning. But is it enough to budge complacency?

With second-tier data on tap for the week ahead, the British Pound may continue to consolidate ahead of the next Bank of England (BoE) interestrate decision on April 14, but fresh rhetoric from Fed officials may generate a near-term rebound in GBP/USD as Chair Janet Yellen endorses a more dovish outlook for monetary policy.

A pickup in the U.K. Purchasing Manager Indices may boost the appeal of the sterling and highlight an improved outlook for the region following the unexpected upward revision in the 4Q Gross Domestic Product (GDP) report. With the economy posting an annualized 2.1% rate of growth during the last three-months of 2015, the BoE may adopt a more hawkish tone over the coming months as the central bank remains adamant that the next move will be to normalize monetary policy. Even though the Monetary Policy Committee (MPC) is widely expected to retain its current policy ahead of the U.K. Referendum in June, a series of positive data prints may generate a near-term rebound in the sterling as it boosts interest-rate expectations.

On the other hand, comments from Boston Fed President Eric Rosengren, Minneapolis Fed President Neel Kashkari, Chicago Fed President Charles Evans, Cleveland Fed President Loretta Mester, Dallas Fed President Robert Kaplan, Kansas City Fed President Esther George and Chair Janet Yellen should the central bank officials try to buy more time. Even though Fed officials forecast two rate-hikes for 2016, the central bank appears to be in no rush to further normalize monetary policy amid the external risks surrounding the U.S. economy. Indeed, Chair Yellen may increase her efforts to tame market speculation as the central bank head adopts a more dovish tone and shows greater concerns surrounding the downward tilt in inflation expectations.

With that said, GBP/USD may enjoy a relief rally during the first full-week of April as market participants continue to gauge the outlook for monetary policy, and a further commitment by Fed officials to ‘gradually’ remove the accommodative policy stance may produce near-term headwinds for the greenback as it dampens bets for a ratehike in the first-half of 2016. In turn, GBP/USD may work its way back towards the top of its current range as the pair remains off of the March low (1.3903) and holds above the 1.4000 handle..

The Japanese Yen finished the week higher versus the fast-falling US Dollar, but key disappointments in domestic economic data and Nikkei 225 losses kept the JPY lower against other major FX counterparts.

Historically we have seen the Yen strengthen (USD/JPY weaken) on domestic equity market sell-offs. And yet this time is different for a key reason—both the Yen and the Nikkei stand to lose if the domestic economy continues to underperform. A sell-off in Japanese stocks into the fiscal yearend (March 31) left the Nikkei in negative territory for fiscal year 2015—the first such annual loss in three years. Profit warnings and disappointing Bank of Japan Tankan survey result forced further sell-offs on April 1, and current price momentum and broader sentiment favors further Japanese equity weakness.

The Yen could nonetheless continue to weaken alongside stocks for one simple reason—economic underperformance will encourage the Bank of Japan to cut interest rates further into negative territory. Indeed, the BoJ sent shockwaves throughout global markets as it surprised most and cut its benchmark overnight rate to -0.10% at its January meeting. Domestic rates subsequently plummeted, and Japanese Government Bond yields are now negative for bonds maturing in under 10 years. Holding funds in Japanese Yen is an expensive proposition if you’re required to pay the government for lending it money.

Continued turmoil and Yen strength in itself lead many to believe the BoJ will move rates lower at its April 27 meeting, and this will only make it worse for domestic investors to receive any real (or nominal) rates of return on their JPY holdings. It is little surprise that individual investors own a miniscule share of total outstanding Japanese Government Bonds—few rational investors would want to pay interest to lend money. The Bank of Japan itself is far and away the largest holder, and their Quantitative Easing program already buys twice the monthly supply of newly-issued JGBs. At some level this represents opportunity—buy government bonds with the expectation that prices will rise as the BoJ steps in. Yet this is also a clear market distortion, and a jump in bond market volatility prices confirms that buying JGBs is a risky proposition.

Thus we may continue to see capital flow out of Japan which itself will keep pressure on the JPY exchange rate. The USD/JPY in particular seems likely to test near-term lows, but that is just as easily a function of US Dollar weakness instead of Yen strength. It would take a fairly significant shift in Bank of Japan policy to improve outlook for the domestic currency.

Monetary policy considerations are front and center for the Australian Dollar in the week ahead, with key event risk on tap on the domestic and the external fronts. First, the RBA will deliver its monthly policy announcement. Then, minutes from the March meeting of the Federal Reserve’s rate-setting FOMC committee will give insight on policymakers’ thinking about on-coming rate hike prospects.

For its part, the RBA is expected to keep the benchmark lending rate unchanged at 2 percent. Markets price in a mere 6 percent chance of a cut this time. Australian economic news-flow began to deteriorate in late January, but this didn’t seem to perturb the central bank last month. Things began to stabilize mid-March, suggesting Governor Glen Stevens and company probably feel comfortable remaining in wait-andsee mode. Signaling as much in the policy statement may make for something of a non-event.

This paves the way for risk appetite trends to take the reins, with the outlook on Fed policy still the theme du jour. We’ve argued that Chair Yellen and company marked a discrete pivot in their policy approach last month. This followed the realization that a wide disparity in official and market-based 2016 tightening bets since December’s “liftoff” (4 versus 2 hikes, respectively) triggered self-defeating risk aversion that undermined their ability to proceed with normalization.

With that in mind, policymakers have taken to repeating a broadly coordinated message arguing that despite adequate progress on mandate fundamentals domestically, rate hikes are being delayed by worries about spillover from outside headwinds. In as much as the concerns being cited are stale at best (the slowdown in China, weak oil prices and a strong US Dollar) and had been dismissed as broadly inconsequential previously even as the threat they posed was more acute, this sounds like code.

Specifically, the Fed wants to avoid triggering another counterproductive market rout when tightening resumes. To that end, it slashed its own forecast to match the setting investors were comfortable with pre-liftoff and seems intent on allowing upbeat US economic data – which has been outperforming relative to forecasts since mid-February – to drive a return there in the priced-in outlook. This will presumably establish realignment allowing for a smooth hike in June.

A critical component to this strategy is the reaction function connecting strong US data and rate hike perceptions. That link breaks down if investors believe external problems are already damaging the outlook. Yellen has already pushed back against this and the Minutes release is another opportunity to do so. If the document stresses that outside threats are being watched but have yet to actually undermine progress toward policy objectives, markets may get the hint and the Aussie may decline as Fed tightening bets rebuild.

Gold prices traded higher this week, with the precious metal advancing 0.58% to trade at 1256 ahead of the New York close on Friday. Despite broader strength in the U.S. equity market, gold maintained its luster as Fed Chair Janet Yellen & Co. alluded to a more gradual pace of policy normalization, with the central bank projecting a slower rate of growth accompanied by softer inflation. As such, the Fed may look to buy more time before implementing the next rate-hike as the board continues to monitor external pressures from global markets.

In light of this week’s FOMC interest rate decision where the committee voiced a more dovish stance on policy, gold prices are likely to remain well supported. As noted last week that the, “Last time around, the (dot) plot showed a median expectation that interest rates will reach 1.25% in 2016 – We’ll be looking for a change in these dot plots with our base case scenario calling for a marked move lower in both the mean and median estimates. Remember that we came into 2016 with expectations the Fed will hike rates four times (now an extremely unlikely scenario) and if the dot plot shows a meaningful reduction in the committee’s expectations for higher rates, look for gold to remain on firm footing as investors seek alternative stores of wealth amid continued central bank easing.”

From a technical standpoint, gold is trading at some tricky levels as the pair struggles to solidify a break above a parallel extending off the 2015 October high as momentum continues to hold below the 70-threshold. The risk remains for a pullback in price with interim support eyed at 1246/50 backed by soft support at 1225& our bullish invalidation level at 1194. We’ll be looking for move lower towards these levels to offer favorable long-entries with a breach of the highs targeting the 2015 high-week close backed at 1294 closely by the 2015 high-day close at 1301. Subsequent topside targets are eyed at the 2014 high week reversal close at 1293.

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