In contrast to the charge the Dollar mounted through the final three-month period of 2016, the benchmark currency seemed to stall through the first quarter of 2017. While not a full tide change, the bulls were much more circumspect about their ambitions. What lies at root to this downshift is an evolving fundamental landscape which may present more problems than support for the Dollar through mid-year. The mathematics of the currency’s advance over the past years was in large part anchored to the aspects of a favorable monetary policy regime from the Federal Reserve. A move to ‘normalize’ monetary policy (hike rates) was an express contrast to the persistent dovish efforts of its global counterparts. In a world still reaching for yield wherever it may be found, the Dollar’s appeal was amplified through sentiment.

Yet, heading into the second quarter; these mechanics were starting to fall apart. Markets had priced in an exceptional hawkish advantage that is both unrealistic and prone to speculative markets moderating their view on ‘risk trends’. Furthermore, the relative advantage afforded by weakened counterparts started to close with other central banks planning withdrawal from dovish extremes and rising trade boundaries threatening to divert capital flow. The second quarter threatens to be an unpredictable – and likely volatile – period for the Greenback and broader financial system.

Rate Speculation Carries a Heavy Bearish Bias

Though it is impossible to attribute an exact quantity, it is reasonable to ascribe a considerable portion of the Dollar’s (ICE Index) 30-plus percent advance over the past three years to the premium the Fed’s measured pace of policy tightening has afforded. That said, that remarkable drive has developed with only three 25-basis point rate hikes in the period through the close of the first quarter. That is a remarkably small, notional advantage that leverages its appeal through the stark contrast to the rest of the developed world’s policy settings. And, therein lies the trouble. While the US central bank has taken great pains to project a gradual pace, the markets have overshot with forecasts for more than just the three total hikes in 2017 that the Fed itself charted out. Below, you can see the market’s probabilities for four total hikes through the year (dark green) and even five (purple). Simply sticking to its initial pace would prove the market over-reaching on the Dollar. Cooling its projects could spur a true correction.