The U.S. dollar gave back a portion of recent gains but remains below levels seen a year ago, and market participants are looking to the Federal Reserve for clearer direction before committing to another major move, according to analysts at Bank of America Securities.
At 08:55 ET (13:55 GMT), the Dollar Index - which measures the greenback against a basket of six other currencies - traded 0.1% lower at 97.400. That followed a 1.5% jump over the prior couple of trading sessions. Despite that rebound, the index is still almost 1% lower year-to-date and down approaching 10% over the last 12 months.
The dollar received upward pressure late last week after U.S. President Donald Trump nominated Kevin Warsh as his pick to be the next Fed chief. Market commentary has interpreted the nomination as increasing the likelihood the next chair will be less inclined to press for rapid rate cuts than some other candidates, while also seeking a reduction in the Fed’s balance sheet.
Bank of America analysts noted signs of improving dollar directional signals in their Jan. 2 research note. They wrote:
"Overall, the latest USD directional quant signals show signs of improvements. Option skews in major USD/G10 pairs turned in favor of the greenback amid a broad-based pick-up in implied vol levels,"
The bank also flagged market structure drivers of the move. In its note, BofA said the size of the commodity selloff triggered the move higher in the dollar and added this dynamic would argue against chasing the dollar lower for now.
Looking ahead, BofA emphasized the role of Fed communication.
"Some further Fed guidance on policy rate and balance sheet under the next Chair would likely be needed for the FX market to re-engage with the next major USD move, in our view," BofA added.
With option skews and implied volatility shifting in favor of the greenback, the market is signaling that positioning and risk premia have changed recently, but analysts say that a clearer policy path from the Fed would be needed before investors reorient decisively toward sustained dollar weakness.
Key points
- The Dollar Index traded 0.1% lower at 97.400 at 08:55 ET (13:55 GMT) after a 1.5% rise over the prior two sessions.
- The index remains almost 1% lower year-to-date and is down approaching 10% over the past 12 months.
- Kevin Warsh's nomination as Fed chair heightened expectations the next chair may be less likely to push for rapid rate cuts and may pursue balance-sheet reduction, which supported the dollar.
Impacted sectors
- Foreign exchange and currency markets - direct impact on USD valuations.
- Commodities - noted as a driver of recent dollar moves.
- Global risk assets and fixed income - likely sensitive to shifts in U.S. rate expectations and Fed balance-sheet plans.
Risks and uncertainties
- Unclear Fed guidance - the FX market may remain rangebound until the Fed provides clearer signals on policy rate and balance-sheet strategy, which affects currency positioning.
- Volatility in commodities - the scale of the commodity selloff contributed to recent dollar strength and could continue to influence near-term dollar moves.
- Market reaction to Fed leadership - the nomination of Kevin Warsh has already shifted expectations, but further comments or policy details from the Fed could change market direction.