Fundamental Forecast for the US Dollar: Neutral

• The US dollar (via the DXY Index) gained +0.65% last week on the back of rising Fed rate hike odds.
• Bond and rates markets are now the most aggressive in their hawkish expectations of the Federal Reserve all year.
• According to the IG Client Sentiment Index, the US dollar has a bullish bias ahead of the September Fed meeting.

US Dollar Aims Higher

After a rocky first few days, the US dollar (via the DXY Index) gained +0.65% last week on the back of rising Fed rate hike odds. Bond and rates markets are now the most aggressive in their hawkish expectations of the Federal Reserve all year. The largest component of the DXY Index, EUR/USD rates, dropped by -0.71 %, while USD/JPY rates gained +0.09%, hampered by weakness in equity markets.

Elsewhere, gains by the greenback were equally if not more pronounced: GBP/USD fell -0.69%; AUD/USD dropped -1.18%; NZD/USD sank -1.06%; and USD/CAD added +0.65%.

US Economic Calendar Packed, Eyes on Fed Meeting

The middle of September will produce another busy docket of event risk based out of the US. Of course, many of the data releases may see reduced importance as the September Fed meeting dwarfs all else.

• On Monday, Sept. 20, the September US NAHB housing market index will be released.
• On Tuesday, Sept. 21, August US building permits and August US housing starts data are due.
• On Wednesday, Sept. 22, weekly US MBA mortgage applications and August US existing home sales will be released in the morning, while the September Fed meeting and press conference by Fed Chair Jerome Powell will take place in the afternoon.
• On Thursday, Sept. 23, the August US Chicago Fed national activity index, weekly jobless claims figures, the September US Markit manufacturing PMI (flash), and August US CB leading index are all due.
• On Friday, Sept. 24, the August US new home sales report will be released and Fed Chair Powell will deliver a speech.

Atlanta Fed GDPNow 3Q’21 Growth Estimate (Sept. 17, 2021) (Chart 1)

Based on the data received thus far about 3Q’21, the Atlanta Fed GDPNow growth forecast has been downgraded from +3.7% to +3.6% annualized.

This was because “a decrease in the nowcast of third-quarter real gross private domestic investment growth from +19.2% to +18.9% was partially offset by an increase in the nowcast of third-quarter real personal consumption expenditures growth from +2.1% to +2.2%, while the nowcast of the contribution of the change in real net exports to third-quarter real GDP growth increased from -1.41% to -1.37%.”

The next update to the 3Q’21 Atlanta Fed GDPNow growth forecast is due on Tuesday, Sept. 21.

Bond Market Expecting a Hawkish Fed

We can measure whether a Fed rate hike is being priced-in using Eurodollar contracts by examining the difference in borrowing costs for commercial banks over a specific time horizon in the future. Chart 2 below showcases the difference in borrowing costs – the spread – for the September 2021 and December 2023 contracts, in order to gauge where interest rates are headed in the interim period between September 2021 and December 2023.

Eurodollar Futures Contract Spread (September 2021 - December 2023) versus US 2s5s10s Butterfly: Daily Rate Chart (September 2019 to September 2021) (Chart 2)

We can overlay Fed rate hike odds with the US Treasury 2s5s10s butterfly in order to gauge whether or not the bond market is acting in a manner similar to what occurred in 2013/2014 when the Fed began to move forward with its taper plans. The 2s5s10s butterfly measures non-parallel shifts in the US yield curve, and if history is accurate, this means that intermediate rates should rise faster than short-end or long-end rates.

Indeed, while Fed rate hike odds were largely unmoved after the July FOMC minutes – which clearly stated the delineating between tapering and rate hikes – we can see that the US yield curve is moving in a manner that suggests a more hawkish Fed is here.

While there are 97-bps of rate hikes discounted through the end of 2023, the 2s5s10s butterfly increased to its highest rate since the Fed taper talk began in June 2021, and its highest overall since June 2018.

US Treasury Yield Curve (1-Year to 30-Years) (September 2019 to September 2021) (Chart 3)

Historically speaking, the combined impact of rising US Treasury yields – particularly as intermediate rates outpace short-end and long-end rates – alongside elevated Fed rate hike odds has produced a more favorable trading environment for the US dollar.

CFTC COT US Dollar Futures Positioning (September 2020 to September 2021) (Chart 4)

Finally, looking at positioning, according to the CFTC’s COT for the week ended Sept. 14, speculators increased their net-long US dollar positions to 24,244 contracts from 21,458 contracts. Net-long US dollar positioning is holding near its highest level since the last week of November 2019.