Fundamental Forecast for US Dollar: Neutral

• Risk trends are keeping the USDollar from a more substantive rally – but an S&P 500 1,850-break can change that

• With vows that the Taper is entrenched, the market will look to Yellen and other Fed speakers for rate guidance

• Have an opinion on the US currency? Trade it via currency baskets

The Dow Jones FXCM Dollar Index (ticker = USDollar) rose every day of the past trading week. We haven’t seen a five consecutive day advance from this benchmark since the run through November 1 – notably the beginning of an impressive bull run for the greenback. Yet, there is something still distinctly absent from the dollar in this turn: conviction. Momentum on this rebound is just as tepid as it was in the 10-day slump that preceded it. So long as the Taper isn’t put on hold or the market isn’t struck by a renewed appetite for expensive ‘risk’ assets, the dollar may be left to drift higher. But if the currency wants to truly rally, traders may need to be inspired by recognition of the Fed’s first rate hike or a S&P 500 collapse below 1,800.

In assessing the dollar’s fundamental bearings, there are two major themes that seem to be capable of taking the rudder over for extended periods: Fed monetary policy speculation and general risk trends. Between the two, investor appetite has the ability to be the most explosive and thereby influential.

It’s no coincidence that the USDollar began its turn when the S&P 500 – a benchmark for investor sentiment – stalled below 1,850. Yet, the halt below record high resistance for the stock index didn’t naturally segue into the long overdue reversal. With the equity market effigy holding just below its all-time highs into the week’s open, it is more likely that we see an upside breakout for stocks and a pang of disinterest for the USD.

Yet, the potential for risk trends is asymmetrical. While probability favors a buildup of risk exposure after a five-year bull trend, the follow through is growing increasingly difficult to muster as participation flags and exposure (leverage and relative high-yield interest) hits record levels. In contrast, fewer traders and greater sensitivity via geared positions marks the kind of conditions that can evolve into a disorderly rush for the exits. A great visualization of this is equity (VIX) or FX-based (FX VIX) volatility index. There is very little risk premium (1.5-3.0 ‘vols’) left before we hit natural / record lows. The correlation between USDollar and the FX VIX is an exceptional 0.83.

The threshold to turn complacency and the grab for yield off pace and ultimately send market participants scrambling is proving exceptionally high. We need something that overrides confidence in a stimulus-protected world. Emerging Markets proved the most provocative threat we’ve seen in some time earlier this month. Yet, the contagion eased before it hit critical mass. We shouldn’t, however, write the risk off though. There is plenty of EM-based event risk this week and the G20 is unlikely to tender a meaningful policy to safeguard the group from its excesses.