US Dollar Under Pressure As Dovish Fed Bets Return On Banking Woes

The US Dollar (USD) struggled to find demand during Tuesday’s American trading hours, and the US Dollar Index (DXY) snapped a three-day winning streak. The USD stays under selling pressure mid-week. The DXY remains negative as investors lean toward a dovish tilt in the Federal Reserve’s (Fed) policy outlook ahead of the interest rate announcement. 

On Tuesday, the heavy selloff seen in the regional banking stocks after the First Republic Bank collapse revived fears over a deepening financial crisis in the United States (US). Market participants grow increasingly concerned about the US economy tipping into recession and see the Fed pausing its tightening cycle after opting for a 25 basis points (bps) rate hike on Wednesday, May 3. 

According to the CME Group FedWatch Tool, the probability of the US central bank raising its policy rate one more time in June is virtually 0%, compared to nearly 40% just a week ago. 

Daily Digest Market Movers: US Dollar Loses Altitude, Eyes On Fed Policy Announcements

  • The Fed is forecast to raise its policy rate by 25 basis points (bps) to 5-5.25% range.
  • FOMC Chairman Jerome Powell will comment on the policy outlook and respond to questions from the press starting at 18:30 GMT.
  • ADP will release the private sector employment report for April ahead of the Fed event. The ISM will publish the ISM Services PMI survey as well.
  • Previewing the Fed event, “uncertainty about the nature of the slowdown and the impact of the banking crisis will likely lead the Federal Reserve to repeat its cautious stance,” said FXStreet analyst Yohay Elam. “I expect this caution to cause investors to hope the Fed has ended its hiking cycle, beginning a pause period followed by cuts. Stocks and Gold would rally on such expectations, while the US Dollar would fall. 
  • The data published by the US Census Bureau revealed on Tuesday that new orders for manufactured goods, Factory Orders, increased $4.9 billion, or by 0.9%, to $539 billion in March.”
  • The US Bureau of Labor Statistics (BLS) announced that the number of job openings on the last business day of March stood at 9.59 million, compared to 9.97 million in February. This reading came in below the market expectation of 9.77 million.
  • The ISM Manufacturing PMI improved slightly to 47.1 in April from 46.3 in March. This reading showed that the contraction in the manufacturing sector’s activity continued, albeit at a softer pace.
  • The ISM’s survey further revealed that the Price Paid sub-index, the input inflation component, climbed to 53.2 from 49.2, playing into the hawkish Fed narrative.
  • US regulators seized First Republic Bank and agreed to sell most of its assets to JPMorgan Chase & Co. last week. The bank reported over $100 billion in deposit outflows in the first quarter.
  • In Tuesday’s first half of the trading session, PacWest Bancorp shares were down more than 30%, while Western Alliance Bancorporation stocks lost over 20%. The financial-heavy Dow Jones Industrial Average lost more than 1% on the day.
  • The European Central Bank (ECB) noted in its Bank Lending Survey that 38% of Eurozone banks reported a fall in demand for credit from companies in the first quarter of the year. The ECB will announce its monetary policy decisions on Thursday.

Technical analysis: US Dollar Index falls below the critical technical level

The Relative Strength Index (RSI) indicator on the daily chart for the US Dollar Index (DXY) retreated below 50 on Wednesday. Additionally, the DXY now stays below the 20-day Simple Moving Average (SMA), currently at 101.80, reflecting the bearish shift in the short-term technical outlook.

On the downside, the DXY could face first support at 101.00 (static level, psychological level) before bears could aim for the critical 100.00 psychological level.

101.80 (20-day SMA) aligns as interim resistance. With a daily close above that level, the DXY could extend its rebound toward 102.50 (static level) and 103.00 (50-day SMA, 100-day SMA).

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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