Dollar analysis: Dollar Index, AUD/USD outlook in focus

• Dollar analysis: Probability of March Fed cut drops on stronger jobs signals ahead of NFP
• Dollar Index tests key resistance – potential for bearish reversal
• AUD/USD outlook boosted by Chinese data

The dollar weakness observed during the early European session faded somewhat once US investors came into the fray. Stronger employment data helped to further reduce the probability of a rate cut at the Fed’s March meeting. The yen was the weakest link, while the euro and pound were still clinging on to small gains against the greenback at the time of writing, helping to keep the Dollar Index in the negative territory. Investors’ attention will now turn to the official jobs report, due for release on Friday, before the focus shifts to inflation data next week.

Here's our full NFP Preview, written by my colleague Matt Weller.

Dollar analysis: Probability of March Fed cut drops

At the end of 2023, the market had priced in a March rate cut with almost 90% probability. However, at the start of this year, those odds have started to fall back, with the market now about 66% confident that the Fed will deliver its first trim in the March 20 meeting. As well as the recent push back by the Fed, investors have realised they may have gotten ahead of themselves in almost fully pricing in a rate cut as soon as March, even though the Fed has indicated the rate cut will come later in the year. So, the dollar’s renewed strength this week has been driven by investors reducing their previously high expectations for a significant dovish shift by the Federal Reserve. They have been a little more doubtful so far this week, as some investors clearly feel that the market may be overestimating the rate cuts.

Stronger employment signals ahead of NFP

Today’s stronger ADP and jobless claims data support the view of a later than earlier cut, which is why the dollar is refusing to budge, despite its bearish trend. The ADP non-farm payrolls report printed 164K versus 120K expected, and weekly jobless claims data showed claims for unemployment benefits rose by 202K applications last week, which was well below 217K expected and 220K from the previous week. A day earlier, we saw the employment component of the ISM manufacturing PMI beat expectations – although at 48.1 it still remained below the expansion level of 50.0, it was nonetheless much better than 45.8 print of the previous month.

If the dollar eases back, these are the currencies to watch

The dollar could easily resume lower again, given that the Fed has made it clear that the US interest rates could be cut at least 3 times this year anyway. There’s the potential for upcoming US data to be more subdued, while the potential for a stronger recovery outside of the US could boost the appeal of foreign currencies. In fact, we have seen some evidence of a recovery in important economic regions around the world this week, helping some commodity dollars, the pound and euro all to attempt a recovery after their own poor start to 2024.

Dollar analysis: EUR/USD boosted as Eurozone and Chinese PMIs beat expectations

Earlier today, the Eurozone final PMIs saw an unexpected upward revision, following positive outcomes in German and Spanish employment data the day before. This development has provided support for the euro and earlier exerted downward pressure on the dollar index, particularly since the euro holds the largest weighting on DXY at 57.6%. Additionally, China reported stronger-than-anticipated Caixin manufacturing (50.8) and services (52.9) PMIs, alleviating concerns about the well-being of the world's second-largest economy and its role as the largest importer of various raw materials.

Dollar analysis: AUD/USD on watch for potential recovery if base metals get a demand boost

Not surprisingly, the Australian dollar, which at the end of last year demonstrated strength, could be a major currency to watch for outperformance should we see strong demand for things like copper and iron ore as a result of a rebounding Chinese economy. Australia is the leading global exporter of iron ore and one of the major producers of copper. Furthermore, with a robust rebound in crude oil prices on Wednesday, the Canadian dollar also has the potential to make a comeback. It is also worth watching the Chinese yuan, which underperformed sharply last year. A stronger Chinese economy will also be good news for Eurozone exports, indirectly supporting the euro.

AUD/USD technical analysis  

The AUD/USD was testing key support around the 0.6690 - 0.6700 area at the time of writing. Here, previous resistance meets the 21-day exponential moving average, with the rising trend line coming in just below. A recovery from around these levels should not come as surprise give the fact that the trend on the AUD/USD has turned bullish in recent months, after rates broke above the 200-day day, which is now also sloping higher. The next support below here is at 0.6610/15 area. If the AUD/USD rebounds from here, the bulls’ next targets will be the pools of liquidity resting above the highs of December and June, at 0.6871 and 0.6900, respectively. The February 2023 high at 0.7158 is the subsequent bullish target.

Dollar index technical analysis

The rebound of the DXY at the beginning of this year follows a consecutive two-month decline at the close of the previous year. During that timeframe, it experienced an increase in only two out of the nine weeks. Consequently, the recovery observed so far this week has been primarily driven by profit-taking from oversold levels. It is reasonable to anticipate this recovery to diminish as it approaches resistance levels, given the prevailing bearish trend that will persist until indicated otherwise by the charts.

As per the chart, the DXY was testing an important resistance area around current levels, as characterised by the convergence of old support and the resistance trend line of the bearish channel established since the end of October and the beginning of November. Additionally, the 21-day exponential moving average is positioned here, solidifying it as a critical resistance zone.

Source for all charts used in this article: TradingView.com

-- Content created by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R