Dollar Falling Out Of Favour On Forex Market

The dollar comes into this week out of favour on markets. The reassessment by markets of Fed rate hike expectations, against a backdrop of heightened global macro concerns and less hawkish Fed comments, brought some downside pressure to bear on the currency last week. At the start of the year, the market had been expecting two 25bps rate hikes this year. However, US futures contracts indicate that the market does not now expect another rate increase by the Fed until Q2 next year. The currency is down by between 1.5-3.5% on the exchanges since last Monday’s open. This has seen some key dollar pairs fall out of recent ranges.

EUR/USD has tested back up near $1.12, after having been below $1.09 in the early part of last week. Likewise, GBP/USD has regained some upward momentum after its ‘Brexit’ related weak start to the year. The pair has managed to trade back up in the $1.45 territory. A key determinant of dollar direction over the coming months will be the evolution of Fed policy.

The most recent FOMC projections (Dec’15) had indicated four 25bps hikes this year. However, the January FOMC statement had a somewhat cautious tone, while last week a key FOMC member (Dudley) expressed a less hawkish stance. Therefore in terms of the week ahead, Fed Chair Yellen’s semi-annual testimony to Congress (Wed & Thurs) will be very much the centre of market attention. Markets will be assessing her comments for more definitive signs that the Fed is leaning towards a more cautious approach to rate hikes. While this would come as no surprise to markets, nonetheless her comments, if very much on the cautious side could provide an additional headwind to the dollar this week.

Janet Jellen predicament

This Wednesday and Thursday Janet Jellen will address lawmakers in Washington. She will have to sound positive about the US economy while at the same time minimising her expressions about the global economies impact on US economic growth. Especially as during the fourth quarter last year, US companies reduced investment.

Currently an interest rate increase in March is priced in at a 10% chance from 50% at the start of the year. One key indicator that the Fed achieved last month was unemployment fell below 5%, to 4.9%. Anything below 5% is considered full employment by the Federal Reserve.

Next will be a continued focus on inflation both on consumer spending and the average PMI index which includes the services and manufacturing sector. Any weaknesses within these indicators may cause the Federal Reserve to wait until June or July which is what markets are currently expecting. Regarding consumer spending, people can watch for any pay increases within upcoming job reports for indicators of future inflation on the consumer side.

Could the Aussie be under further pressure?

An economist at the Australia New Zealand Banking Group believes that if the Federal Reserve was to stick to four 25 basis points increases this year, you could see the Aussie fall to AUD/USD $0.50. He suggested a guideline of AUD/USD $0.65 - $0.60 if condition were to remain the same and the Fed did not make four interest rate increases.

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