US DOLLAR FUNDAMENTAL FORECAST: BULLISH

• US Dollar gains as Fed’s Powell unpacks updated policy framework
• On-trend core inflation clashes with dovish shift in rate hike outlook
• Incoming news may fuel rebound as ‘data dependence’ is established

The US Dollar fell for a third consecutive week, succumbing to weakening yield- and haven-based appeal as priced-in Fed rate hike prospects fizzled while risk appetite recovered. Futures markets now predict the central bank will forego tightening altogether in 2019. Meanwhile, the bellwether S&P 500 index has climbed to the highest in a month.

A snapshot of weekly performance obscures what looks to be a critical change in the underlying fundamental narrative however. Markets have been taken with the idea of a dovish turn in the consensus view on the FOMC policy-setting committee for some weeks. Last week, Chair Powell seemed to ratify the idea that – while a change in posture has indeed occurred – this does not imply commitment to a directional bias.

POWELL CHECKS DOVISH TURN IN FED POLICY OUTLOOK

In fact, this seems to be the substance of the adjustment. In the decade following the Great Recession, the Fed sought to reassure markets with policy stability by telegraphing its moves well in advance. With the stimulus withdrawal process underway in earnest and the so-called “neutral” rate in sight, officials have moved into fine-tuning mode: dispensing with pre-commitment and adopting a nimbler approach.

Speaking at the Economic Club in Washington DC on Thursday, Mr. Powell spelled out in the clearest terms yet that this need not be inherently dovish. He once again acknowledged a plethora of potential headwinds including trade tensions with China, shaky European politics and the ongoing US government. Critically however, he asserted none of these have materially soured incoming economic data flow.

The Greenback offered a telling response, rising alongside bond yields as the priced-in policy path implied in Fed Funds futures edged away from recent dovish extremes. More of the same followed as December’s CPI report underscored Powell’s point on the very next day. The headline price growth reading ticked lower courtesy of a slump in crude oil, but the core measure held reassuringly on-trend at 2.2 percent.

US DOLLAR EYEING BARRAGE OF ECONOMIC DATA

The calendar is loaded with economic activity data in the coming week. Figures on inventories, retail sales, industrial production, housing starts and building permits are all due. The University of Michigan will also update its US consumer confidence gauge. If traders have finally onboarded what the Fed is saying, the expectation of open-minded data dependence might see any of these stoke outsized volatility.

US economic news flow has sharply improved relative to consensus forecasts since the calendar yearturn. That suggests the setting of analysts’ models has been much too pessimistic, opening door for continued outperformance on incoming releases. That may well prompt a deep rethink of the markets’ no-hike 2019 policy view, setting the stage for the US Dollar to recover.