US Dollar Forecast: US inflation returns to the fore
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UPGRADE- US Dollar Index (DXY) reversed part of its pullback this week.
- The Fed’s interest rate cut in September appears almost priced in.
- US PCE should be the salient event next week.
Immediately to the upside comes the 200-day SMA
An auspicious second half of the week was enough to encourage the US Dollar (DXY) to close a week of decent gains and reverse two consecutive weekly retracements.
Indeed, the initial broad-based advance in the risk-linked universe sent the USD Index (DXY) to four-month lows in the 103.70-103.65 band, just to reverse that move in the last couple of days and reclaim the area beyond the 104.00 milestone in the context of an equally acceptable rebound in US yields across different time frames.
Despite the index breaking below the critical 200-day SMA earlier in the week, this was not a convincing breach, leaving the door open to the continuation of the recovery in the short-term horizon.
The divergence in monetary policy remains well in place
The sharp decline in the DXY over the past week was solely driven by investors adjusting their expectations for the timing of a Federal Reserve (Fed) interest rate cut, which is now seen joining the majority of its G10 peers sooner than previously thought.
This adjustment kicked in soon after US inflation data, measured by the Consumer Price Index (CPI), fell short of consensus in June, while some cooling of the domestic labour market also helped in that matter.
A glimpse at the central bank's space shows the European Central Bank (ECB) delivering a dovish hold on July 18 after trimming its interest rates by 25 bps in early June. The Swiss National Bank (SNB) unexpectedly cut rates by another 25 bps at its gathering last month, and the Bank of England (BoE) is now predicted to postpone a potential rate cut in August in light of the still sticky UK inflation figures. Furthermore, the Bank of Japan (BoJ) delivered a dovish message on June 14, and a rate hike in July looks unlikely for the time being. The exception, in the meantime, remains the Reserve Bank of Australia (RBA), as it is expected to begin its easing cycle in the second half of 2025.
Investors’ bets are placed on September and December
The increasing market speculation about an earlier start to the Fed's easing cycle was bolstered by positive data and a shift towards a not-so-hawkish narrative from some Fed officials.
With the re-emergence of a downward trend in domestic inflation and a recent slowdown in key areas such as the labour market and the services sector, market participants increased their exposure to the first rate cut in September, followed by an extra one in December. This expectation sharply contrasts with the Federal Open Market Committee's (FOMC) projection of just one rate cut, likely at the December 18 meeting.
However, the likelihood of a third interest rate reduction should involve an acceleration of the disinflationary pressures in combination with an incessant deterioration in the labour market; both scenarios are actually quite improbable.
According to the CME Group's FedWatch Tool, there is approximately a 98% chance of rate cuts at the September 18 meeting, while lower rates in December are a done deal.
A “softening” of the Fed’s narrative opens the door to rate cuts
On Monday, Federal Reserve Chair Jerome Powell remarked that the three inflation readings over the second quarter "add somewhat to confidence" that the pace of price increases is returning to the Fed's target sustainably, indicating that interest rate cuts may not be far off. In addition, Federal Reserve Governor Adriana Kugler expressed cautious optimism that inflation is returning to the bank’s 2% goal, with goods, services, and housing contributing to easing price pressures. Furthermore, New York Federal Reserve President John Williams, argued that an interest-rate cut could be warranted in the coming months. Finally, Federal Reserve Governor Christopher Waller mentioned that the time for an interest rate cut "is drawing closer," although he noted that uncertainty about the economic path makes the timing of a reduction in short-term borrowing costs unclear.
It’s the economy! (as well)
Monetary policy divergence is predicted to remain a key player when it comes to potential extra gains in the Greenback. This likely uptrend also finds common ground with the persistent carry trade, while firm expectations of a “soft landing” of the US economy should also emerge as a significant factor underpinning the view of a stronger Dollar in the long run.
Upcoming key events
Moving forward, next week should be a very interesting one in terms of data releases, as flash Purchasing Manages Indexes (PMIs) are due for the month of July, seconded by the advanced GDP Growth Rate in the April-June period, and inflation gauged by the Personal Consumption Expenditures (PCE).
Techs on the US Dollar Index
Further recovery should place the key 200-day SMA at 104.39 as the immediate target for bulls. Once this region is surpassed, DXY is expected to meet its next resistance of note at the June high of 106.13 (June 26), prior to the 2024 top of 106.51 (April 16). Further north from here is the November peak of 107.11 (November 1), ahead of the 2023 high of 107.34 (October 3).
On the other hand, if bears regain the upper hand, the index could initially slip back to the July low of 103.65 (July 17) ahead of the weekly low of 103.17 (March 21). Down from here emerges the March low of 102.35 (March 8), followed by the December bottom of 100.61 (December 28), all preceding the psychological 100.00 milestone.
The DXY should regain its constructive outlook once it clears the 200-day SMA on a sustainable fashion.
Economic Indicator
Personal Consumption Expenditures - Price Index (YoY)
The Personal Consumption Expenditures (PCE), released by the US Bureau of Economic Analysis on a monthly basis, measures the changes in the prices of goods and services purchased by consumers in the United States (US). The YoY reading compares prices in the reference month to a year earlier. Price changes may cause consumers to switch from buying one good to another and the PCE Deflator can account for such substitutions. This makes it the preferred measure of inflation for the Federal Reserve. Generally, a high reading is bullish for the US Dollar (USD), while a low reading is bearish.
Read more.Last release: Fri Jun 28, 2024 12:30
Frequency: Monthly
Actual: 2.6%
Consensus: 2.6%
Previous: 2.7%
Source: US Bureau of Economic Analysis
Inflation FAQs
Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.
Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.
Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it. Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.
- US Dollar Index (DXY) reversed part of its pullback this week.
- The Fed’s interest rate cut in September appears almost priced in.
- US PCE should be the salient event next week.
Immediately to the upside comes the 200-day SMA
An auspicious second half of the week was enough to encourage the US Dollar (DXY) to close a week of decent gains and reverse two consecutive weekly retracements.
Indeed, the initial broad-based advance in the risk-linked universe sent the USD Index (DXY) to four-month lows in the 103.70-103.65 band, just to reverse that move in the last couple of days and reclaim the area beyond the 104.00 milestone in the context of an equally acceptable rebound in US yields across different time frames.
Despite the index breaking below the critical 200-day SMA earlier in the week, this was not a convincing breach, leaving the door open to the continuation of the recovery in the short-term horizon.
The divergence in monetary policy remains well in place
The sharp decline in the DXY over the past week was solely driven by investors adjusting their expectations for the timing of a Federal Reserve (Fed) interest rate cut, which is now seen joining the majority of its G10 peers sooner than previously thought.
This adjustment kicked in soon after US inflation data, measured by the Consumer Price Index (CPI), fell short of consensus in June, while some cooling of the domestic labour market also helped in that matter.
A glimpse at the central bank's space shows the European Central Bank (ECB) delivering a dovish hold on July 18 after trimming its interest rates by 25 bps in early June. The Swiss National Bank (SNB) unexpectedly cut rates by another 25 bps at its gathering last month, and the Bank of England (BoE) is now predicted to postpone a potential rate cut in August in light of the still sticky UK inflation figures. Furthermore, the Bank of Japan (BoJ) delivered a dovish message on June 14, and a rate hike in July looks unlikely for the time being. The exception, in the meantime, remains the Reserve Bank of Australia (RBA), as it is expected to begin its easing cycle in the second half of 2025.
Investors’ bets are placed on September and December
The increasing market speculation about an earlier start to the Fed's easing cycle was bolstered by positive data and a shift towards a not-so-hawkish narrative from some Fed officials.
With the re-emergence of a downward trend in domestic inflation and a recent slowdown in key areas such as the labour market and the services sector, market participants increased their exposure to the first rate cut in September, followed by an extra one in December. This expectation sharply contrasts with the Federal Open Market Committee's (FOMC) projection of just one rate cut, likely at the December 18 meeting.
However, the likelihood of a third interest rate reduction should involve an acceleration of the disinflationary pressures in combination with an incessant deterioration in the labour market; both scenarios are actually quite improbable.
According to the CME Group's FedWatch Tool, there is approximately a 98% chance of rate cuts at the September 18 meeting, while lower rates in December are a done deal.
A “softening” of the Fed’s narrative opens the door to rate cuts
On Monday, Federal Reserve Chair Jerome Powell remarked that the three inflation readings over the second quarter "add somewhat to confidence" that the pace of price increases is returning to the Fed's target sustainably, indicating that interest rate cuts may not be far off. In addition, Federal Reserve Governor Adriana Kugler expressed cautious optimism that inflation is returning to the bank’s 2% goal, with goods, services, and housing contributing to easing price pressures. Furthermore, New York Federal Reserve President John Williams, argued that an interest-rate cut could be warranted in the coming months. Finally, Federal Reserve Governor Christopher Waller mentioned that the time for an interest rate cut "is drawing closer," although he noted that uncertainty about the economic path makes the timing of a reduction in short-term borrowing costs unclear.
It’s the economy! (as well)
Monetary policy divergence is predicted to remain a key player when it comes to potential extra gains in the Greenback. This likely uptrend also finds common ground with the persistent carry trade, while firm expectations of a “soft landing” of the US economy should also emerge as a significant factor underpinning the view of a stronger Dollar in the long run.
Upcoming key events
Moving forward, next week should be a very interesting one in terms of data releases, as flash Purchasing Manages Indexes (PMIs) are due for the month of July, seconded by the advanced GDP Growth Rate in the April-June period, and inflation gauged by the Personal Consumption Expenditures (PCE).
Techs on the US Dollar Index
Further recovery should place the key 200-day SMA at 104.39 as the immediate target for bulls. Once this region is surpassed, DXY is expected to meet its next resistance of note at the June high of 106.13 (June 26), prior to the 2024 top of 106.51 (April 16). Further north from here is the November peak of 107.11 (November 1), ahead of the 2023 high of 107.34 (October 3).
On the other hand, if bears regain the upper hand, the index could initially slip back to the July low of 103.65 (July 17) ahead of the weekly low of 103.17 (March 21). Down from here emerges the March low of 102.35 (March 8), followed by the December bottom of 100.61 (December 28), all preceding the psychological 100.00 milestone.
The DXY should regain its constructive outlook once it clears the 200-day SMA on a sustainable fashion.
Economic Indicator
Personal Consumption Expenditures - Price Index (YoY)
The Personal Consumption Expenditures (PCE), released by the US Bureau of Economic Analysis on a monthly basis, measures the changes in the prices of goods and services purchased by consumers in the United States (US). The YoY reading compares prices in the reference month to a year earlier. Price changes may cause consumers to switch from buying one good to another and the PCE Deflator can account for such substitutions. This makes it the preferred measure of inflation for the Federal Reserve. Generally, a high reading is bullish for the US Dollar (USD), while a low reading is bearish.
Read more.Last release: Fri Jun 28, 2024 12:30
Frequency: Monthly
Actual: 2.6%
Consensus: 2.6%
Previous: 2.7%
Source: US Bureau of Economic Analysis
Inflation FAQs
Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.
Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.
Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it. Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.
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