US Dollar Forecast: DXY extends gains on policy divergence, focus on PCE inflation data

• The US Dollar Index (DXY) advanced for the third week in a row.
• Investors believe that the Fed might cut rates twice this year.
• Next on the upside for the US Dollar comes the 2024 high.

Focus remains on the yearly peak around 106.50

The Greenback had a notably positive week, reaching levels close to the 106.00 barrier, an area last seen in early May, as indicated by the US Dollar Index (DXY). The index rose for the third consecutive week, mainly driven by the widening gap in monetary policy between the Federal Reserve (Fed) and almost all of the other G10 central banks.

Divergences here and there

A glance at part of the recent performance of the Greenback notes that it has managed to regain strength against risk-sensitive currencies following a sharp pullback due to lower-than-expected US inflation figures in May, as indicated by the Consumer Price Index (CPI).

That resurgence of buying interest in the US Dollar has come pari passu with investors’ adjustment to the June 12 Federal Open Market Committee (FOMC) event, when the Fed matched the broad consensus and maintained the Fed Funds Target Range (FFTR) unchanged at 5.25%–5.50%. Furthermore, the Committee signalled only one interest rate cut this year, which is most likely to be delivered in December.

However, the resumption of the disinflationary pressures, along with some loss of impetus, mainly in the US labour market (as per JOLTs prints as well as recent weekly jobless claims), the manufacturing sector, and weakened consumer confidence, all appear to have encouraged market participants to start pencilling in two interest rate reductions by the central bank this year, with September and December emerging as likely candidates.

What do Fed officials say?

At the Fed’s last meeting, Chair Jerome Powell and most members emphasized that the start of an easing cycle requires more confidence that inflation is steadily moving towards the bank’s 2% target, which is not yet the case.

Those views have remained unchanged so far. In fact, earlier in the week, Boston Federal Reserve President Susan Collins cautioned against overstating recent inflation data, asserting that the Fed should wait for clearer signs of easing price pressures before considering rate reductions. In addition, Richmond Fed President Thomas Barkin suggested that he needs to analyze several more months of economic data before supporting a rate cut. In the same line, St. Louis Federal Reserve President Alberto Musalem indicated that the bank should only consider reducing interest rates after a sustained period – possibly lasting months to quarters – of declining inflation, tempered demand, and increased supply. His colleague at the Federal Reserve Bank of New York, John Williams, remarked that interest rates will gradually decrease over time, though he did not specify when the central bank would begin easing monetary policy. Finally, Minneapolis Fed President Neel Kashkari advised that it could take one or two years for inflation to reach the Fed’s target.

Nevertheless, the likelihood of lower rates stands at about 66% for the September 18 meeting, and nearly 95% by the end of the year, according to the FedWatch Tool by CME Group.

US yields kept the consolidative theme intact

The continuation of the intense upside momentum post-FOMC hiccup in the Greenback did not echo in the US yields so far this week, which remained stuck within their consolidation theme in the lower bound of the recent range across the spectrum.

G10 Central Banks: Navigating rate cuts and inflation

Among G10 central banks, the European Central Bank (ECB) reduced its rates by 25 bps at its meeting on June 6, while the Swiss National Bank (SNB) surprised markets by cutting its rates by an extra 25 bps on June 20 and the Bank of England (BoE) delivered a dovish hold on the same day. In the same tone, the Bank of Japan (BoJ) leant towards a dovish message on June 14. On the opposite side of the road, the Reserve Bank of Australia (RBA) is likely to begin easing in the first half of next year, while, according to the latest gathering, the Fed could start reducing its rates by year-end.

That said, the current policy divergence between the Fed and its peers is likely to widen further in the next few months, which should be supportive of a stronger Dollar moving forward.

Upcoming key events

Next week will be of light activity data-wise, with the publication of US inflation figures measured by the Personal Consumption Expenditures (PCE) as the salient event (June 28).

Techs on the US Dollar Index

Following recent lows in the 104.00 neighbourhood, the US Dollar Index (DXY) regained strong momentum and marched to fresh multi-week tops in levels shy of the 106.00 hurdle.

Should the index break above the June high of 105.89 (June 21), it might dispute the 2024 peak of 106.51 (April 16). Once the latter is cleared, the index might embark on a potential test of the November high of 107.11 (November 1) prior to the 2023 top of 107.34 (October 3).

On the downside, DXY is expected to meet initial contention at the key 200-day SMA of 104.48, ahead of the June low of 103.99 (June 4). A deeper decline could test the weekly low of 103.88 (April 9) prior to the March low of 102.35 (March 8) and the December bottom of 100.61 (December 28), all before the psychological contention zone at 100.00.

Meanwhile, the Dollar’s constructive stance should remain unchanged while above the key 200-day SMA.