US Dollar Gains As Hawkish Fed Tone Underpins Greenback

Dollar decline

The US Dollar (USD) Is clawing back after its lackluster performance on Wednesday, where traders tried to keep their powder dry for the US Federal Reserve (Fed) rate decision. The consensus is that, although there is a rate pause, the hawkish undertone was firm and will play a role in the coming months. Meanwhile, China’s central bank, the People’s Bank of China (PBOC), has cut rates on 1-year loan rates from 2.75% to 2.65%.

With the Fed meeting out of the way, traders do not have much time to rethink their strategy as a big slew of data is just around the corner again this Thursday. Retail Sales are set to hit the wires out of the US at 12:30, joined by Initial Jobless Claims, NY Empire State Manufacturing, and Philadelphia Fed Manufacturing Index. Big focus and importance as well at the other side of the Atlantic Ocean as the European Central Bank (ECB) is to announce another rate hike to 4%, with a press conference at 12:45 GMT where ECB Chairman Christine Lagarde will elaborate on the other rate path for the Eurozone. 

Daily Digest: US Dollar Demand Flairs Up As Focus Shifts To Europe

  • The Greenback advances nearly 1% against the Japanese Yen as traders prepare for the BoJ meeting on Friday. 
  • Traders across the Atlantic Ocean are gearing up for the European Central Bank (ECB) rate decision at 12:15 GMT with a speech from its chair Christine Lagarde at 12:45 GMT.
  • In between these, at 12:30 GMT, the market gets a view on US Retail Sales, where a small drop is expected in both the core and overall numbers and Jobless Claims. 
  • Some Manufacturing data will also come from New York with the NY Empire State Manufacturing Index and Philadelphia with the Fed Manufacturing Index. These smaller economic numbers could ease the hawkish move from the Fed if they all point to lower activity, less growth. or even contraction. 
  • The PBOC has cut its 1-year loan rate to 2.65% from 2.75%.
  • On Wednesday, US Fed Chairman Jerome Powell mentioned during a press conference that inflation pressures remain high after their rate pause. Inflation still needs to get back to 2%, which will be a long way. The Fed will remain data dependent and will decide on a meeting-by-meeting basis. Again, Powell reiterated that core inflation is their main and biggest issue and needs to be brought down further. 
  • Except for China, all other major indices are red in Asia and Europe. The US equity futures are all three in the red, and the dust settles over the hawkish stance of the Fed. 
  • The CME Group FedWatch Tool shows that markets are pricing in a 71.9% chance of a 25 basis point (bp) hike on July 26th.  Overall, the point of view here seems to be just one more hike and done, as all other futures for 2023 are pointing to an unchanged rate level. 
  • The benchmark 10-year US Treasury bond yield trades at 3.81%. During the Fed rate pause announcement, it briefly peaked at 3.85%. The result is slightly lower, with the European trading session kicking into gear.

US Dollar Index Technical Analysis: Sell The Rumor, Buy The Fact

The US Dollar is a perfect example of selling the rumor and buying the fact, as the Greenback weakened in the wake of the US Fed rate pause decision and rallied substantially afterward. This made the Dollar Index (DXY) make a knee-jerk reaction after it dipped below 103 and was on its way to 102.57. With the DXY back above 103, it will be essential to see if the index can close above 103 to rally higher in the coming days. 

On the upside, 105.37 (200-day Simple Moving Average) still acts as a long-term price target to hit. The next upside key level for the US Dollar Index is at 105.00 (psychological, static level), which acts as an intermediary element to cross the open space.

On the downside, 103.05 (100-day SMA) aligns as the first support level to confirm a trend change. If that breaks down, watch how the DXY reacts close to the 55-day SMA at 102.57 to assess any further downturn or upturn. 

How Does Fed’s Policy Impact US Dollar?

The US Federal Reserve (Fed) has two mandates: maximum employment and price stability. The Fed uses interest rates as the primary tool to reach its goals but has to find the right balance. If the Fed is concerned about inflation, it tightens its policy by raising the interest rate to increase the cost of borrowing and encourage saving. In that scenario, the US Dollar (USD) will likely gain value due to decreasing money supply. On the other hand, the Fed could decide to loosen its policy via rate cuts if it’s concerned about a rising unemployment rate due to a slowdown in economic activity. Lower interest rates are likely to lead to a growth in investment and allow companies to hire more people. In that case, the USD is expected to lose value.

The Fed also uses quantitative tightening (QT) or quantitative easing (QE) to adjust the size of its balance sheet and steer the economy in the desired direction. QE refers to the Fed buying assets, such as government bonds, in the open market to spur growth, and QT is precisely the opposite. QE is widely seen as a USD-negative central bank policy action and vice versa.

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