US Dollar Forecast: Focus shifts to US data and Fedspeak

• US Dollar Index (DXY) drops for second straight week.
• Softer-than-expected US CPI-fuels rate cut bets for September.
• Retail Sales, FedSpeak emerge as salient events next week.

The corrective decline broke below the 200-day SMA

The selling pressure in the FX world continued to punish the Greenback this week, sending the USD Index (DXY) back to the 104.00 region, or multi-week lows, against the backdrop of the strong pick-up in expectations surrounding the timing of the start of the Federal Reserve’s (Fed) easing cycle.

In addition, the pronounced retracement of the US Dollar (USD) also breached the always-relevant 200-day SMA (104.44), hinting at the idea that further weakness may be in store for the currency in the next few days.

Is the Fed’s policy divergence dwindling? 

The acute decline in the index over the past week exclusively followed investors’ repricing of the timing of an interest rate cut by the Fed. This scenario strongly emerged after US inflation figures measured by the Consumer Price Index (CPI) fell short of consensus in June, rising by 3.0% over the last 12 months and by 3.3% when excluding food and energy costs, the so-called Core CPI. The higher-than-expected Producer Price Index published on Friday, however, did nothing but raise an eyebrow among investors.

If we add the recent cracks in the US labour market, which kept suggesting further cooling, the picture pointing to a weaker US Dollar does nothing but strengthen on the short-term horizon. 

In the meantime, the euro area, Japan, and the United Kingdom face an acceleration of disinflationary pressures. The European Central Bank (ECB) reduced its rates by 25 bps early in June and is largely anticipated to keep rates on hold at its July 18 meeting. 

Additionally, the Swiss National Bank (SNB) surprised markets with another 25 bps cut on June 20, while the Bank of England (BoE) maintained a dovish stance at its gathering last month. Similarly, the Bank of Japan (BoJ) conveyed a dovish message on June 14. An exception is the Reserve Bank of Australia (RBA), which is projected to begin its easing cycle in the second half of 2025.

So… one, two or three interest rate cuts?

The increasing market speculation about an earlier start to the Fed's easing cycle was underpinned by “good data”. In light of the re-emergence of the downtrend in domestic inflation, along with a recent slowdown in key areas such as the labour market and the services sector, market participants now dare to anticipate a third interest rate cut by the Fed to occur in the latter part of the year. This prospect, however, contrasts sharply with the Committee’s projection of just one interest rate reduction, likely to occur at the December 18 meeting.

According to the FedWatch Tool by CME Group, there is approximately a 94% chance of rate cuts at the September 18 meeting and around 97% of lower rates in November, while a rate cut in December is almost fully priced in.

US yields validated the steep correction in the Dollar

The US money market kind of “accompanied” the Dollar’s strong pullback, as yields in the short end of the curve retreated to levels last seen in early March vs. multi-week lows in the belly of the curve and monthly lows in the long end.

The Fed remains cautious in light of rising rate cut bets

Another indication of increasing disinflationary pressures in the US emerged shortly after Chair Jerome Powell, in his semi-annual testimonies, expressed some confidence that inflation is headed lower but was not yet prepared to say he was sufficiently confident it would sustainably decrease to 2%.

Regarding the US CPI data, St. Louis Fed President Alberto Musalem commented that consumer price data is moving in the right direction, noting that inflation data shows a slowdown and aligns with price-sensitive consumers. He also expressed confidence that current monetary policy is appropriate and argued that he is monitoring the data to see if inflation continues to moderate towards the 2% target. Meanwhile, San Francisco Fed President Mary Daly anticipated further easing in price pressure and the labour market, which she believes would justify interest rate cuts.

Upcoming key events

Next on tap on the US calendar will be the release of Retail Sales for the month of June (July 16) and July’s Philly Fed Manufacturing Index (July 18). In addition, as usual, Fedspeak should keep investors entertained.

Techs on the US Dollar Index

The DXY broke below the key 200-day SMA of 104.44.

The continuation of the bearish trend could prompt the US Dollar Index to revisit the June low of 103.99 (June 4) prior to the weekly low of 103.88 (April 9), and the March low of 102.35 (March 8). Further south aligns the December bottom of 100.61 (December 28), before the psychological contention of 100.00.

In case buying interest returns to the market, DXY is expected to meet its initial upside barrier at the June top of 106.13 (June 26), just below the 2024 peak of 106.51 (April 16). Once it clears this region, the Index could embark on a potential move to the November high of 107.11 (November 1) ahead of the 2023 top of 107.34 (October 3).