- US Dollar Index drops for second consecutive week.
- US disinflationary trends remained well in place in August.
- Fed is largely anticipated to cut rates by 25 bps next week.
The pessimism around the US Dollar (USD) intensified in the latter part of the week, sending the US Dollar Index (DXY) back into negative territory for the second consecutive time on the weekly chart.
A glimpse at the DXY’s price action so far in September signals quite a decent resistance zone just below the 102.00 barrier, although the broader bearish outlook is expected to remain unchanged while below the critical 200-day SMA at 103.85.
The weekly decline was mainly driven by investors’ adjustments to the most likely 25 basis points (bps) cut to the Federal Reserve’s (Fed) Fed Funds Target Range (FFTR) at its meeting on September 18.
In the meantime, concerns over a potential “hard landing” of the US economy seem to have dissipated for the time being.
The decision is made: It will be a 25 bps rate cut
Despite the commencement of the Fed’s easing cycle never being under scrutiny, the size of the first interest rate cut has been under persistent debate over the last few weeks.
Until last Wednesday, in fact, following the publication of mixed Nonfarm Payrolls for the month of August on September 6, investors’ attention shifted to inflation. On this, the release of the US inflation data measured by the Consumer Price Index (CPI) on Wednesday showed further confirmation that the disinflationary pressures remained well and sound in August.
Still around inflation, a report released on Monday by the New York Federal Reserve indicated that the US public's expectations for inflationary pressures remained largely unchanged last month, even as current price pressures continued to ease. The New York Fed's latest Survey of Consumer Expectations showed that, in August, respondents anticipated inflation to be at 3% one year from now and 2.8% five years from now, consistent with the levels reported in July. The survey also revealed that respondents expected inflation to be 2.5% three years ahead, up from 2.3% in July.
In fact, and despite a small uptick in the Greenback soon after the CPI release, market participants have started to unwind their Dollar’s positions, putting the DXY under increasing pressure and motivating it to once again break below the key 101.00 support towards the end of the week.
It is worth recalling that Fed Chair Jerome Powell opened the door to rate cuts in his speech at the Jackson Hole Symposium in late August, a view that was subsequently reinforced by other Fed policymakers: Atlanta Federal Reserve President Raphael Bostic warned that high interest rates could harm employment. San Francisco Fed President Mary Daly suggested cutting interest rates to maintain a healthy labour market, but the extent of the cuts would depend on upcoming economic data. Federal Reserve Bank of New York President John Williams suggested a more balanced economy created the possibility for rate cuts, with the exact course of action depending on future economic performance. Finally, Fed Governor Christopher Waller and Chicago Fed President Austan Goolsbee advocated for multiple interest rate cuts to support full employment and align wage growth with the 2% inflation target.
According to the CME Group's FedWatch Tool, there is around a 57% chance of a quarter-point rate cut in September, while the likelihood of a 50-basis-point cut stands at about 43%.
After the anticipated rate cut in September, market participants are expected to shift their focus to evaluating the performance of the US economy to better predict any future rate cuts.
Currently, investors have priced in around 250 basis points of easing over the next twelve months. While earlier concerns about a recession seem to have lessened, upcoming economic data could still influence the Fed's monetary policy decisions.
Outlook on international monetary policy: What’s next?
The Eurozone, Japan, Switzerland, and the United Kingdom are all facing increasing deflationary pressure. In response, the European Central Bank (ECB) implemented its second interest rate cut on Thursday and maintained a cautious stance regarding any potential move in October. While ECB policymakers remain uncertain about additional rate cuts, markets are already pricing in two more reductions later this year.
Similarly, the Swiss National Bank (SNB) surprised markets with a 25-basis-point cut on June 20, and the Bank of England (BoE) followed with a quarter-point cut on August 1. Meanwhile, the Reserve Bank of Australia (RBA) took a different approach by keeping rates unchanged at its August 6 meeting, while sticking to a hawkish narrative in subsequent comments. Market expectations suggest the RBA could start easing rates sometime in Q4 2024.
In contrast, the Bank of Japan (BoJ) took markets by surprise on July 31 with a hawkish move, raising rates by 15 basis points to 0.25%. Despite the recent hawkish tone from some BoJ officials, money markets see only 25 bps of tightening by the central bank in the next 12 months. At its gathering next Friday, the central bank is expected to keep rates unchanged.
When politics meets economics
Since the latest US presidential debate, the Democratic Party's presidential candidate and US Vice- President, Kamala Harris, appears to be leading the run-up to the upcoming US election on November 5 by a slight margin vs. Republican candidate and former US President Donald Trump. It is important to consider that a second Trump administration, along with the possible reinstatement of tariffs, could disrupt or even reverse the current disinflationary trend in the US economy, potentially leading to a shorter period of Fed rate cuts. Conversely, some analysts argue that a Harris victory might result in higher taxes and increased pressure on the Fed to ease monetary policy if economic growth begins to slow.
What’s up next week?
The Fed meeting will be the key event to watch next week. Meanwhile, the release of Retail Sales data for August on Tuesday will also play an important role by providing further insights into consumer spending trends. Additionally, data on Industrial Production, the Philly Fed Index, and the usual weekly jobless claims will offer more clues on the overall health of the US economy.
Techs on the US Dollar Index
The chances of continued downward pressure on the US Dollar Index (DXY) have risen after it broke decisively below the important 200-day Simple Moving Average (SMA), currently positioned at 103.85.
If the bearish momentum continues, the DXY could first target the 2024 low of 100.51, recorded on August 27, and then the psychologically important 100.00 level. Further south emerges the 2023 bottom of 99.57, seen on July 14.
Bullish attempts should meet immediate resistance at the September top of 101.95, seen on September 3, prior to the weekly peak of 103.54 from August 8 and the critical 200-day SMA.
The day-to-day Relative Strength Index (RSI) has returned to the sub-40 region, accompanying the bearish price action in the index.
Fed FAQs
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.
US Dollar FAQs
The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022. Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.
The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.
In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.
Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.
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