US Dollar Forecast: Positive outlook remains in place

The US Dollar Index clinches its sixth weekly gain in a row.
The Federal Reserve cut its primary interest rate by 25 bps on Thursday.
Investors will closely follow potential Trump policies and data.

The US Dollar (USD) has been on a roll for yet another week, notching up a solid performance over the past few days and extending its winning streak to a sixth straight week. The Greenback even surpassed the critical 200-day Simple Moving Average (SMA) at 103.85 when measured by the Dollar Index (DXY) — a level we haven't seen since early July.

The ongoing rally kicked off early in October, and it was constantly fed by firm results from US fundamentals and, more recently, by the so-called “Trump trade” and the Federal Reserve’s (Fed) interest rate cut at its November 7 gathering.

As we look ahead, the US Dollar's outlook could turn even more bullish if it manages a decisive breakout above the key 200-day SMA.

And back to inflation!

Following the widely anticipated quarter-point interest rate reduction by the Fed earlier this week, Chair Jerome Powell acknowledged that recent inflation figures have been higher than expected. However, he also pointed out that downside risks remain, noting that the Fed might need to adjust its pace of rate cuts.

Powell also suggested that if inflation continues to surprise on the upside, rate cuts could be more gradual, while a faster deterioration in the labour market might prompt the central bank to cut rates more aggressively.

Against that, Powell once again reiterated that the US economy remains in a “very” good place, and substantially more so if we bring its G10 peers into focus.

The “Trump trade” should initially be supportive of the Dollar

In light of the return of Donald Trump to office, with Republican control in both the Senate and possibly the House, we could see a major shake-up in US economic policy.

In fact, President-elect Trump has over and over voiced his intentions to increase tariffs on Chinese and European goods, a move that is expected to drive up inflation while putting a brake on economic growth in the longer run.

On the flip side, tax cuts and deregulation from a Republican-led Congress might help cushion the potential impact on economic growth, but their consequences might increase the budget deficit, fanning the flames of the resurgence of inflationary pressure.

As the Fed has started shifting its focus away from inflation to take a closer look at the labour market, the overall performance of the US economy is now playing a key role in shaping future policy moves.

In October, the Nonfarm Payrolls (NFP) report showed a modest gain of just 12K jobs, with the Unemployment Rate steady at 4.1%. While the ADP report beat expectations, weekly jobless claims have been suggesting that the labour market remains strong, although it's cooling off at a snail’s pace.

Recent GDP data also paints a positive picture, countering fears of an impending recession. At this point, neither a soft landing nor a hard landing seems likely.

Compared to other G10 economies, the US stands out, which could keep the US Dollar on a stronger footing against its peers over the medium to long term.

Deciphering rate moves: A global outlook

The Eurozone, Japan, Switzerland, and the United Kingdom are grappling with increasing deflationary pressure and economic activity becoming increasingly unpredictable.

In response, the European Central Bank (ECB) cut interest rates by 25 basis points on October 17, though officials refrained from providing additional details or forward guidance on the central bank's future actions.

Similarly, the Swiss National Bank (SNB) also reduced rates by 25 basis points on September 26.

The Bank of England (BoE) recently reduced its policy rate by 25 basis points to 4.75%, as the MPC believes the new budget will boost both growth and inflation, which means they can’t afford to lower interest rates too quickly or by too much. However, they still expect inflation to come under control by the end of 2025.

The Reserve Bank of Australia (RBA) held rates steady at its November 5 meeting but struck a cautious note, with markets anticipating a potential cut to the official cash rate (OCR) by May 2025.

Over in Japan, the Bank of Japan (BoJ) stuck to its dovish approach at the October 31 meeting, with markets expecting only a modest 25-basis-point rate hike over the coming year.

What’s up next week?

The highlight of next week will once again be the release of October's inflation data, as tracked by the Consumer Price Index (CPI). Meanwhile, the regular weekly updates on the labour market will also be in focus. They will take a backseat but still be relevant.

Additionally, it will be worth watching for any comments from Fed officials, especially in light of the recent rate cut by the central bank.

Techs on the US Dollar Index

As the US Dollar Index (DXY) continues its upward climb, the next key target is the November high of 105.44 (November 6), seconded by the June top of 106.13 (June 13).

On the downside, the November low at 103.37 (November 5) comes first prior to the provisional 100-day and 55-day SMAs at 103.07 and 102.35, respectively, ahead of the 2024 bottom of 100.15 (September 27).

Additionally, the Relative Strength Index (RSI) on the daily chart rose past the 63 level, while the Average Directional Index (ADX) has inched up to above 38, indicating that the current trend has moderate strength.

Fed FAQs

What does the Federal Reserve do, how does it impact the US Dollar?

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.

How often does the Fed hold monetary policy meetings?

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.

What is Quantitative Easing (QE) and how does it impact USD?

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.

What is Quantitative Tightening (QT) and how does it impact 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.

Inflation FAQs

What is inflation?

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%.

What is the Consumer Price Index (CPI)?

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.

What is the impact of inflation on foreign exchange?

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.

How does inflation influence the price of Gold?

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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