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DailyFX
Dollar at Risk of Reversal if Fed Hints at More QE
John Kicklighter

  • Dollar at Risk of Reversal if Fed Hints at More QE

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Dollar at Risk of Reversal if Fed Hints at More QE

With Tuesday’s 0.3 percent decline, the Dow Jones FXCM Dollar Index (ticker = USDollar Index) has dropped for five consecutive days. Matching the longest series of declines since January 2012, we may see a true break to trend reversal depending on how the Fed judges policy. A look at the greenback’s chart presents a currency at the floor of a two-month congestion pattern just above 10,400 and meaningfully capped by 10,600 – the mid-point of the index’s range over the past five years. In other words, this aggregate measure of the US dollar reflects indecision at a two-and-a-half year high; which presents a considerable risk of reversal. The same risk is present with many of the greenback’s most liquid counterparts. EURUSD stands just below 1.3200, USDJPY is eying 96.50 and GBPUSD is knocking on the mid-point of this year’s range at 1.5575. A definitive catalyst is the best means for sparking a breakdown or driving the dollar back from the brink.

It is important to recognize something immediately with the upcoming Federal Open Market Committee’s (FOMC) rate decision: the policy group is unlikely to change its actual policy. That means that we shouldn’t expect a change to the current extracurricular stimulus program (also called QE3) - much less a change in rates. However, that doesn’t mean the event is not going to be market-moving. In fact there is a high probability of a significant reaction from the dollar and other risk-sensitive assets depending on how the deliberations go. The Fed’s influence is tied to the market’s speculative effort to time the slowing and eventual end of the $85-billion-per-month stimulus effort.

Over the past few months, central banker commentary has led to the impression of a shifting ‘mean’ amongst policy officials that the QE3 program should be slowed sometime in the third or fourth quarter and possibly ended by year-end. This leads to tentative optimism for the dollar but it also is a source of fear for those that would otherwise plow into riskier assets. As a measure of global return potential, the aggregate 10-year government bond yield from the majors is just off its lowest level on record. This extreme lack of return contrasts record highs in benchmarks like the S&P 500, yet it is sustained by the assumption that central banks will prevent adverse price movements though their efforts. It is this same belief that would leverage a dollar breakdown and risk rally if stimulus were expanded for longer than previously thought…

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