US DOLLAR OUTLOOK: FX IMPLIED VOLATILITY MUTED AHEAD OF FOMC RATE DECISION
- US Dollar has struggled throughout the month of April as bears unwind prior gains
- Federal Reserve dovishness looks likely to continue weighing down the US Dollar
- Implied currency volatility suggests the upcoming FOMC decision may be boring
The US Dollar has lacked direction so far this week and trades practically flat gauging by the DXY Index. This follows a sharp extension lower since the start of April that leaves the broader US Dollar down -2.5% month-to-date. US Dollar selling pressure has largely coincided with softer Treasury yields on the heels of Federal Reserve officials stating adamantly that policy will remain accommodative for the foreseeable future. In turn, this has contributed to less attractive US interest rate differentials. The ten-year Bund to Treasury spread, for example, is now 16-basis points higher from where it was at the end of March. Seeing that EUR/USD price action tends to broadly track this fundamental driver, and considering this major currency pair is the largest component of the DXY Index with a 57.6% weighting, recent US Dollar weakness comes as little surprise.
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Looking ahead to Wednesday’s trading session, which will have the FOMC rate decision in the spotlight, we can see that implied volatility readings for the US Dollar are fairly muted for what is typically a high-impact risk event. This suggests that we will hear more of the same from the Federal Reserve and Chair Jerome Powell during tomorrow’s Fed announcement. Nevertheless, there remains a small chance that Fed Chair Powell blinks on his calls for transitory inflation and hints at a potential roadmap for tapering policy. Any slight shift away from keeping the foot on the gas for the central bank’s printing press could catalyze a big influx of volatility and US Dollar demand, but it is most likely that FOMC officials continue to convey a patient approach to removing monetary support.
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Though this would be in contrast to the Bank of Canada and their recently announced plans to taper its own QE program from C$4-billion to C$3-billion a week. This brings to focus monetary policy divergence between the Fed and BoC, which threatens to keep exerting downward pressure on USD/CAD price action. That said, USD/CAD is expected to be one of the most volatile major currency pairs during Wednesday’s trading session. USD/CAD overnight implied volatility of 8.5% is above its 20-day average reading of 5.9% and ranks in the top 87th percentile of measurements taken over the last 12-months.
— Written by Rich Dvorak, Analyst for DailyFX.com
Connect with @RichDvorakFX on Twitter for real-time market insight
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