Dollar tops performer list once again

The Dollar is finding some serious reprieve from a painful three months of selling pressure. Over the past three weeks, the currency has advanced between 0.8 and 5.0 percent (versus the British Pound and Australian Dollar respectively). Rather than finding its motivation in external sources like thematic risk trends or strong crosswinds from motivated counterparts, the advance is proving innate. The FOMC minutes this past week finally cracked the speculative rank’s skepticism over the potential for 2016 rate hikes. However, that revival of credibility also opens the door to greater sensitivity to another run of charged Fed-speak in the week ahead. Will the leverage in volatility be worth the market’s acquiescence?

While a 28 percent probability of a FOMC rate hike on June 15 – the next scheduled FOMC minute complete with forecasts and Chairwoman press conference – may not seem profound, compared to the rigid incredulity of follow-up 2016 rate hikes in the wake of the December ‘liftoff’ is remarkable. Only a week ago (May 13), the market was pricing a scant 4 percent probability of a move at the next meeting. A chance of a full 25 basis point hike through the end of the year was only 53 percent on the same day. That had significantly undermined one of the Dollar’s most profound fundamental drivers over the past four three-plus years.

It is worth looking back at the minutes this past week to see why they had such a profound impact. Qualitatively, the view the group took was not materially more optimistic or aggressive than previous meetings. Sure, the absence of ‘global’ pressures was welcome, but the emphasis of ‘two-to-three hikes in 2016’ – as SF Fed President John Williams stated – has been the standard language among the group. Recognizing the persistence of the market’s discount to their own view, the Fed realized the need to deliver a greater sense of certitude that a hike could be on the agenda or risk a shock of volatility to the system when tightening did come around – which would invariably make their job far more difficult and likely force an immediate course reversal. The heavy inference of a ‘June’ move and balance of confidence in reduced negative risks provided the crucial push.

With the break in skepticism, we don’t have an unchallenged Dollar climb ahead of us – the choppy progress of the past week verified as much. However, it does open the market to greater sensitivity to tangible changes in the data and policy group rhetoric moving forward. For data, the listings are light. New homes sales and PMI figures are the most holistic measures for central banks to chew on – and they do not touch upon the critical areas of policy decisions (global risks and oil prices rather than general full employment and broad inflation). The abundance of Fed rhetoric scheduled ahead, however, will compensate nicely.

There are 9, officially-scheduled speeches on the docket through the coming week, and some of their content will be particularly palatable to rate speculators. St. Louis Fed President Bullard will speak about policy normalization on Monday, Minneapolis Fed President Kashkari (to this point vague on policy standing) will discuss energy and monetary policy Wednesday, and Fed Chair Yellen is set to speak on Friday. Expect rate forecasts to swing on key words – hawkish and dovish – while the Dollar follows along.

And, as always, a cautious eye needs to be kept on the influence of nonscheduled themes moving forward. Global speculative appetite in particular is of great consequence to the entire financial system and the Dollar as a safe-haven-of-last-resort. Volatility measures for most assets are low, but it is building in FX. What’s more, the sense of calm this should provide is not present. Rather, we see the opportunistic and anxious proclivities of a market that recognizes an end to easy times is drawing near.

The British Pound put in a strong week of gains through Thursday, snapping the two-week losing streak that the Sterling put in against the US Dollar after running up to a new ninemonth high earlier in May. Friday was a markedly different story, as GBP put in an aggressive drop after some interesting commentary from two members of the Bank of England.

Kristin Forbes is an external member of the Monetary Policy Committee of the BoE, and in comments overnight she mentioned that the recent slowdown in UK data may not be entirely Brexit-related. This was somewhat contradictory to the tone taken on during Super Thursday just a week earlier, in which the Bank of England rang alarm bells towards the potential consequences of a vote to leave the European Union, saying that higher unemployment, higher inflation, lower growth and a ‘sharp’ decline in the British Pound would follow should voters choose to leave the EU. At that meeting the bank had said that approximately half of the 9% decline in the British Pound since November could be attributed to Brexit risks. This also gave the inference that the recent slowdown in GDP (to .4% in Q1 from .6% in Q4 2015) may have been caused by the risk of the upcoming Brexit vote. Ms. Forbes offered a slightly different vantage point, and this was somewhat of an extension of what we heard from fellow MPC member Gertjan Vlieghe not more than 24 hours earlier.

Ms. Forbes mentioned that there is ‘fog over the data,’ referring to the fact that it’s near-impossible to attribute how much of the recent slowdown in British economic data can truly be attributed to the risk of a Brexit. She did acknowledge the logic of businesses to remain risk averse with such a profound vote slated for next month; but she also said that there is a ‘chance that other things are going on.’

And in a speech at London Business School on Thursday, BoE member Gertjan Vlieghe made similar claims in saying that he feared that any economic bounces coming after a ‘remain vote’ may be short-lived. This is similar to Ms. Forbes’ comments in indicating that there may be weakness under the surface that isn’t entirely Brexitrelated. Mr. Vlieghe mentioned that low rates may be on the table for the Bank of England for years, perhaps even decades; pointing to an aging British population and heavy levels of debt held by consumers within the economy. Mr. Vlieghe said that the BoE should be ready to cut interest rates in order to stimulate spending in the event that an economic bounce after a remain-vote turns out to be short-lived.

These were both starkly dovish outlays, and this was likely a prime driver of the weakness seen in GBP to end this week.

On the docket for next week we have just one piece of high-impact data, and even that report might be down-played. This is the 2nd estimate GDP numbers from Q1 of this year. No revisions are expected here, but should this number be revised significantly higher or lower we’ll likely see GBP move in that direction (revisions higher bringing strength, while revisions lower entail weakness). But far more important at this point-in-time is the forward-looking analysis/fear of what may come from the Brexit vote looming just a month away.

Due to the intense uncertainty as we near a historic vote, we’ll retain our neutral forecast until a true macro-economic trend becomes clearer.

A lull in high-profile event risk leaves the Australian Dollar without readily-available fundamental catalysts in the week ahead. This puts prices at the mercy of risk sentiment trends as financial markets continue to focus on establishing big-picture narratives leading up to potentially explosive volatility next month.

Prospects for a Federal Reserve interest rate hike at the June or July policy meetings jumped last week on the back of overtly hawkish rhetoric from central bank officials in speeches and within minutes from April’s FOMC meeting. Investors now see a better-than-even chance of an increase by July having previously discounted tightening at least until December.

From here, May’s flash US PMI readings, the Durable Goods Orders report and revised first-quarter GDP figures will inform investors on the Fed’s wherewithal to make good on its aggressive language. US data outcomes have cautiously improved relative to consensus forecasts over the past week, opening the door for upside surprises that may bolster tightening bets and trigger risk-off trade, weighing on the Aussie.

On the Fed-speak front, traders will be keen to evaluate remarks from Governor Jerome Powell. Presidents of regional Fed branches have seemed consistently more hawkish than the three members of the Board of Governors outside of Chair Yellen and Vice Chair Fischer. If Mr. Powell’s remarks mirror the hawkish tone of last week’s commentary, they may go a significant way toward boosting the probability of an imminent hike in the minds of investors.

The looming “Brexit” referendum represents the other major theme in play. A poll of polls by the Financial Times shows 47 percent of respondents now favor the UK staying within the EU while 41 percent back leaving it. As the June 23 vote draws closer, pre-positioning is likely to become more active and updated polling numbers will probably stoke a greater degree of volatility.

Gains for the “Bremain” camp are likely to prove supportive for risk appetite and the Aussie alike, while increased chances of a “Brexit” outcome generate the opposite results. Whatever the merits of the arguments on either side of the debate, financial markets loathe uncertainty. With that in mind, it seems only logical that investors would prefer the status quo to an unprecedented exit of a major member state out of the EU.

The near-term advance in USD/CAD may gather pace in the week ahead should the Bank of Canada (BoC) endorse a dovish outlook for monetary policy, while Federal Reserve officials show a greater willingness to implement higher borrowing-costs over the coming months.

The BoC is widely anticipated to retain its current policy at the May 25 interest- rate decision, but Governor Stephen Poloz and Co. may adopt a more cautious outlook for the region as Finance Minister William Morneau sees the Alberta fire having a ‘modest’ impact on economic activity. Despite the stickiness in Canada’s Consumer Price Index (CPI), the slowdown in job growth accompanied by the weakening outlook for global growth may prolong the rebalancing of the real economy, and the loonie stands at risk of facing near-term headwinds should the BoC adopt a more cautious tone this time around.

At the same time, fresh comments from St. Louis Fed President James Bullard, San Francisco Fed President John Williams, Philadelphia Fed President Patrick Harker, Minneapolis Fed President Neel Kashkari, Dallas Fed President Robert Kaplan, Fed Governor Jerome Powell and Fed Chair Janet Yellen may fuel a further advance in USD/CAD as the central bank appears to be on course to further normalize monetary policy over the coming months. Even though the Federal Open Market Committee (FOMC) remains ‘data-dependent,’ the central bank may continue to prepare households and businesses for higher borrowing-costs especially as the U.S. economy approaches ‘full-employment.’

With that said, growing speculation for a looming Fed rate-hike may pave the way for a fresh monthly highs in USD/CAD, and the long-term upward trend may reassert itself over the near-term amid the deviating paths for monetary policy

Gold prices are down for a third consecutive week with the precious metal off 1.69% to trade at 1251 ahead of the New York close on Friday. The losses come amid continued strength in the greenback with the US Dollar Index closing the week just below key resistance extending off the 2016 high. The outlook for monetary policy continues to be the main focus moving forward with key data next week likely to offer further insight on whether economic conditions warrant an interest rate hike next month.

The release of the FOMC minutes from the latest policy meeting showed committee members remain poised to raise borrowing costs, fueling a marked shift in Fed Fund Futures which are now pricing in a 30% probability for a 25basis point hike next month (up from just 4% ahead of the FOMC minutes this week).

The first material expectation for tightening is in September which is showing a 59% likelihood. The shift has continued to prop-up the greenback at the expense of gold – but these expectations can change rather quickly so we’ll continue to watch key US economic data as committee members remain adamant that the central bank remains largely data dependent.

Looking ahead to next week, traders will be closely eyeing the release of US Durable Goods as well as the second read on 1Q GDP. Note that growth in the first quarter was disappointing (just 0.5% q/q), with consensus estimates calling for an upward revision to 0.8% q/q. Of particular interest will be the release of the Personal Consumption Expenditure (PCE) which is the Fed’s preferred gauge on inflation and a stronger print could further stoke expectations for a June rate hike. We’ll also be looking for a fresh batch of central bank rhetoric with speeches from St Louis Fed President James Bullard, Governor Jerome Powell and Chair Janet Yellen on tap. If expectations for a June hike continue to be brought forward, look for gold remain on the defensive. Although the technical picture remains bleak, the decline is coming into nearterm support targets which may offer prices a near-term reprieve from the recent downside pressure.