USD Q1 2022 Fundamental and Technical Forecasts

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USD Q1 2022 Fundamental Forecast: Dollar's Hawkish Path Is Not Necessarily a Bullish One

The US central bank announced a significant shift in its monetary policy stance to end 2021, but the ultimate impact of the more hawkish bearing seemed to barely register for the Dollar and risk assets in general. If we were to take the lack of direction of this systemically important shift at face value, it would be easy to interpret that some other fundamental consideration is directing the Greenback - or that we have simply disengaged from economic and financial currents altogether. However, it would be short-sighted to believe that some of the most influential winds in the market no longer matter. Anticipation bolstered by forward guidance certainly helped to soften the blow of the late news, but thinned liquidity was arguably the most distortionary aspect. As we move into 2022, markets will fill back out and the Fed will find itself near the hawkish end of the pack. So what course will the Dollar follow into the new year?

THE MONETARY POLICY DEPTH CHARTS

As we enter a new trading year, we also seem to be transitioning into different monetary policy waters. While there are still some very notable doves among the major central banks (such as the European Central Bank and Bank of Japan); the majority are tapering, projecting near-term rate hikes or already lifting their benchmarks. That backdrop is important because it gives context of relative value. Were it only the Federal Reserve that were on course to raise rates while other major peers were static or easing, there would be a distinct carry advantage to the Greenback? That is, of course, a favourable tail wind so long as the post-pandemic risk appetite run carries over uninterrupted into the new year. As it stands, some of the currencies that have enjoyed a carry advantage to the Dollar in the past - including the British Pound, New Zealand Dollar and Canadian Dollar - once again hold a current and forecasted yield premium, yet this is also where the Dollar has gained traction more aggressively over the final two months of the past year.

CHART 1: RELATIVE MONETARY POLICY STANCE – FROM JOHN KICKLIGHTER

Forecasts carry more weight in future movement than do current yield differences. This represents a greater downside risk for the US Dollar through the first three months of the year. At the December 15th FOMC rate decision, the policy statement announced the accelerated pace of taper ($30 billion per month) which would bring QE to an end by end of March, while the summary of economic projections (SEP) raised the forecast for rate hikes in 2022 to three 25 basis point hikes. That is modestly more aggressive than what the market was expecting the central bank to adjust to - from a single 25 bp hike in September - so there is perhaps a little more upside on this fundamental dimension moving forward. However, a further acceleration of rate forecasts is improbable without it representing alternative issues. If the Fed is hiking at a pace faster than three hikes over the span of 9 months, if we consider the first move comes after the end of taper, is fairly aggressive with the state of economic uncertainty. Such a move would likely only come in an environment where other central banks are raising under similar duress from inflation, which would temper the carry potential. Alternatively, if financial pressures build and the US central bank throttles back its forecasts, it would likely lead to a significant loss of altitude for the Greenback.

CHART 2: US RATE CHANGE FORECAST IMPLIED FROM 2022 FED FUNDS CHANGE - DAILY TIMEFRAME (AUGUST TO DECEMBER 2021)

Source: TradingView; Prepared by John Kicklighter

ADDING RISK TRENDS TO THE MIX

There has been a shift in the monetary policy tempo through the second half of 2022 for a reason: inflation has proven more persistent than authorities had bargained for. While there are those that view inflation only in what it means for central bank policy, it is important to remember there are very real-world economic implications. The rise in costs of goods at the wholesale, business and consumer level throttle economic activity. If the slowdown in recovery is too sharp, it can readily compound the existent concerns floating around the market and the rich level of the markets at large, in turn leading to a market retreat. As a carry currency, the Dollar has a lot of ground to lose after the Dollar's charge through the second half of this past year. For those that have traded through more extreme market periods, a bearish view of the US currency during risk aversion may seem counter to everything the textbooks suggest; but the Greenback is more appropriately a haven of last resort. If we slide into a period of 'risk off' that encompasses the entire financial system, then the Dollar may resort to its more rudimentary role. Otherwise, treat it as a risk asset.

CHART 3: DXY DOLLAR INDEX OVERLAID WITH VIX AND 20-WEEK CORRELATION (WEEKLY)

Source: TradingView; Prepared by John Kicklighter

EXTERNAL RISKS THAT AREN'T CENTRAL BANK ANCHORED

With the Dollar's safe haven status in mind and a shift in focus from localized monetary policy, there are other matters that Dollar traders need to contemplate through the opening run of 2022. The complication of the impending US debt limit is a deadline that keeps resetting. After another last-minute delay, threat of an unthinkable US default has shifted to the first quarter of 2022. In all likelihood, the government will find enough support for another delay, but the markets will never doubt this move. More uncertain is the situation with the newest wave of the coronavirus. The omicron variant has seen a resurgence in infections on the coast while certain countries across the ocean have already acted to shut down their economies to halt the spread. Will US officials be forced to eventually follow a similar solution?

By John Kicklighter, Chief Strategist, 26th December 2021. DailyFX

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USD Q1 2022 Technical Forecast: King Dollar’s Test Atop the Throne

For a year in which the USD spent much of the outing in a range, it was a great year for US Dollar volatility.

The currency came into 2021 with a full head of steam in the bearish trend. A major level had come into play around the 90.00 handle, which was confluent with a Fibonacci level plotted at 89.92. This is the 38.2% retracement of the 2001-2008 major move. It stalled the sell-off in December 2020 and as the door opened into 2021, a continued grind at this level in January led to a lift in February and March.

That lift was very much driven by the prospect of the reflation trade, punctuated by hope that vaccines would bring on an eventual end to Covid and allow us all to go back to living our lives. Well, that didn’t happen, and in Q2 that bullish flare deflated in the USD and price action made a trip right back to 89.92 Fibonacci support, which held the lows in May.

Another lift began to develop ahead of the Q4 open, however, as the Fed finally started to signal a higher rate regime on the way, largely in response to inflation that still hasn’t tamed. This drove price action all the way up to the 38.2% retracement of that same major move, and as we sit just a couple of weeks away from New Year’s Day, 2022, that price is helping to hold near-term support in the USD.

US DOLLAR INDEX (DXY) – MONTHLY TIMEFRAME (2001 TO PRESENT)

Source: TradingView; Prepared by James Stanley

USD BREAKOUT RUNS TO A BIG ZONE – AND HOLDS

That bullish theme in the US Dollar was very loud in Q4, and it even got its start ahead of the actual open. As I had highlighted in the Q4 forecast, there was an ascending triangle formation in the US Dollar, which pointed to bullish breakout potential.

That breakout hit shortly after the September FOMC rate decision, the point at which the bank started to forecast rate hikes for next year. That gave the initial break but what seemed to do a lot of the pushing was inflation data that just continued to grow throughout the quarter. This drove the USD up to a fresh 2021 high until, eventually, price action found a confluent zone of Fibonacci levels running from the 38.2% retracement looked at above, up to the 96.47 level, which is the 23.6% Fibonacci retracement of the 2017-2018 major move.

That price was also the final target from the Q4 technical forecast and as we near the 2021 open, and it’ll likely remain in the picture as we move into 2022 trade.

From the weekly chart we can see where price action put in a series of dojis near that confluent spot on the chart. That’s a massive amount of indecision after a really strong run. Normally, a doji showing at a key resistance level after a really strong run would favor pullbacks, but the fact that price hasn’t pulled back yet despite multiple weeks of equalized price action in this tight area is, in and of itself, deductively bullish. That means that there are buyers defending the line-in-the-sand, and this is one of the reasons that the Q1 Technical Forecast for the US Dollar is set to bullish.

Timing that theme may be a challenge, however, as a pullback cannot be ruled out. The question then is, even if a pullback does show, is it likely to unsettle the bigger picture trend? I don’t believe that to be the case, and there’s even an ideal area for that pullback to move towards, and this would be the 38.2% retracement of the 2020-2021 sell-off move. This was also a spot of resistance that came into play shortly after that Q4 breakout but, as yet this spot hasn’t been tested for support. A pullback to this level around 94.47 can keep the door open for continuation.

On the topside, breakout potential remains at the recent highs and how soon this shows will likely be determined by just how strong inflation data remains in early 2022 trade.

DOLLAR INDEX (DXY) – WEEKLY TIMEFRAME (JUNE, 2018- PRESENT)

Source: TradingView; Prepared by James Stanley

Q1 2022 FORECAST FOR THE US DOLLAR: BULLISH

The technical forecast for the US Dollar will remain at bullish for Q1, 2022. And the reasons for this aren’t entirely technical, as the fundamental backdrop is, in my opinion, too compelling to ignore.

A major part of the US Dollar price is the Euro, which constitutes more than 57% of the DXY quote. So when looking at USD projections it’s important to incorporate the Euro. And the divergence showing between the two economies seems too profound to allow for continued range.

But, as the USD ran into this major area of confluent resistance, EUR/USD has pushed down to a major area of confluent support – so the matter will likely need a push before fresh highs can be established in the USD or fresh lows in EUR/USD. I think this push can emanate in one of two ways: Either inflation in the U.S. remains so high that the trend breaks from fundamental driver. Or, the US Dollar retreats to support at 94.50 as EUR/USD pushes for resistance around 1.1448-1.1500, at which point the bigger picture trend can avail itself with USD-strength and EUR/USD-weakness.

For support potential in USD, the 38.2% retracement of the recent bullish trend lines up at 94.11, and this can be combined with the 94.47 level to create a ‘zone’ of potential support to look to for bullish continuation scenarios.

DOLLAR INDEX (DXY) – DAILY TIMEFRAME (MAY, 2021- PRESENT)

 

By James Stanley, Senior Strategist, 25th December 2021. DailyFX