Weekly Fundamental US Dollar Forecast: Inflation Fears Linger; May US NFP Due Friday

Weekly Fundamental US Dollar Forecast: Inflation Fears Linger; May US NFP Due Friday

Fundamental Forecast for the US Dollar: Neutral

  • The ongoing erosion of US real yields, thanks to rising inflation expectations and stagnant US Treasury yields, proved to be a negative influence on US dollar price action – like it was for much of 2020.
  • For now, without a corresponding rise in US Treasury yields, we’ve seen the start of a tantrumless taper, if you will.
  • According to the IG Client Sentiment Index, the US dollar has a mixed bias heading into the first week of June.

US Dollar Stumbles out of May

The US dollar (via the DXY Index) did not have a good month of May, despite favorable seasonality conditions otherwise. The ongoing erosion of US real yields, thanks to rising inflation expectations and stagnant US Treasury yields, proved to be a negative influence on US dollar price action – like it was for much of 2020. Now coming off of what should have been its best month of the year, the US dollar remains vulnerable for further downside.

But the best hope for a more significant US dollar turn around would be if commodity prices are able to pullback while US economic data outperforms, provoking a churn towards higher US nominal yields and lower inflation expectations, would which otherwise lift US real yields.

Evidence of Shifting Fed Policy?

The Federal Reserve will be keeping rates low and stimulus flowing for the foreseeable future. At least that’s what the conventional wisdom has been in recent weeks. But what started with a small quip in April may now be something more significant: markets are beginning to react to the Fed’s interpretation of incoming inflation data – or lack thereof.

Federal Reserve Interest Rate Expectations (May 28, 2021) (Table 1)

Weekly Fundamental US Dollar Forecast: Inflation Fears Linger; May US NFP Due Friday

True, as has been the case for weeks, Fed funds futures are pricing in around a 10% chance of a change in Fed rates through January 2022. But beneath the surface, there has been seemingly scary high volumes across the Fed’s open markets desk, suggesting that liquidity is being drained from the system.

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For full US economic data forecasts, view the DailyFX economic calendar.

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