In Q3 2021 futures markets turned net US dollar (USD) positive for the first time in 15 months. Expectations of Federal Reserve monetary policy tightening were driving flow into the USD. However, into 2022 there are signs of a shift in the tide. As a crucial Fed meeting approaches, market participants are beginning to close out their long USD positions. This suggests that tighter US rates have been fully priced, which would restrict the USD recovery.

  • Positive USD futures are now unwinding
  • What could the Fed meeting do to turn sentiment more positive again?
  • USD forex pairs are trading with a negative risk appetite bias

Positive net USD futures position starting to reverse 

Forex futures markets remain net-long on the USD. However, after a few months of consolidation, the first signs of a serious reversal are starting to show through.

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This trend is important as there is a clear positive correlation between the futures contracts and the outlook for the US dollar. 

This all comes ahead of the Fed meeting on Wednesday and is a sign that markets have fully priced in expectations of Fed tightening in 2022. According to CME Group FedWatch, there is now a 95% probability that the Fed will start to increase rates in March, with around 70% probability that there will be as many as 4 hikes by the end of this year. 

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We believe that the USD is in the process of having topped out in its bull run higher of the past 7 months because markets have already reacted to the prospect of four rate hikes in 2022. It is highly unlikely that there would be a fifth (or even sixth).

Only a significantly hawkish FOMC would drive consistent USD gains

The USD has rebounded slightly in the past ten days. However, the USD is trading lower for the whole of 2022, during a time in which safe havens have benefitted from the NASDAQ selling pressure. This lack of performance for the USD also tells us that traders are thinking elsewhere now.

Omicron is showing signs of waning in the US and Europe. Other central banks are giving off hawkish hints. The positive traction for the USD from the tightening prospects of the Fed has seemingly played out.

The only factor that could change this now would be a significant hawkish jolt from the Fed. Perhaps this could be a surprise end to asset purchases at this meeting (would be about a month early). However, would the Fed want to do this with Wall Street already under significant corrective strain? This would be an unnecessary move for sentiment reasons (even if the economic arguments of still making asset purchases are limited now).

The Fed could signal a much more aggressive tightening. For signs of this, we would need to watch Fed Chair Powell’s press conference but more likely FOMC member comments in the coming weeks. The March dot plots would also give more of an indication of whether this may be seen. At this stage though, it would be unlikely.

USD outlook versus major forex

Despite all this though, coming into the FOMC meeting this week, it seems that the higher risk/pro-cyclical currencies are under the most pressure. This reflects the risk negative outlook of major forex and is helping to support USD on a near-term basis.

  • GBP/USD has broken below 1.3600 and is now testing the support of the next higher low at 1.3490. The support band 1.3410/1.3490 is key for Cable. GBP is under pressure from a rebounding USD, weaker than expected UK flash PMIs but also political risk hitting GBP.

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  • AUD/USD has broken its uptrend channel and is now eyeing support at 0.7130. A close under 0.7130 would open 0.7080.
  • NZD/USD is breaking down below 0.6700 for a new low dating back to November 2020. The next key support is 0.6510/0.6590.

However, the picture is less positive for the USD versus the safe-haven currencies. This is especially the case versus the outperforming Japanese yen and Swiss franc. Even the Euro is still holding on to its uptrend channel.

EUR/USD is hanging on to support at 1.1300 within the uptrend channel. The recovery remains intact whilst the support of the higher low at 1.1270 is intact.

USD/JPY has fallen sharply in recent sessions with a key safe haven bias on flow into the JPY. Pressure towards 113.15/113.45 is still live and intraday rallies are a chance to sell.

USD/CHF has fallen to the bottom of a 5-month trading range. Key support of the range lows at 0.9085/0.9100 is being tested.

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