Dollar forecast: DXY extends gains for third day

The US dollar traded higher for the third day against a basket of foreign currencies. As well as finding support from Powell’s not-so-dovish comments earlier this week, we have seen some stronger labour market indicators to reduce the odds of another outsized rate cut this year. Boosting the dollar forecast further has been the escalation in the Middle East conflict. The greenback is therefore likely to remain on the front-foot while geopolitical risks remain elevated and ahead of the US jobs report on Friday. The latter could then determine which direction the greenback will want to take in the near-term, before the focus turns to US presidential election.

Geopolitical tensions impact dollar forecast

The dollar forecast has been influenced by escalating tensions in the Middle East, with markets factoring in heightened geopolitical risks. The recent missile exchange between Israel and Iran has traders closely watching Israel's next move, as any retaliation could send further shockwaves through global markets. Israel has vowed to respond while intensifying its ground offensive in parts of Lebanon.

Still, for the second time this year, the prospect of de-escalation hovers in the background. Should Israel opt for a measured response—avoiding strikes on sensitive sites such as Iran's nuclear infrastructure—the markets may stabilise, as investors could perceive the situation as contained in that scenario. However, if the conflict intensifies, markets will likely price in even greater risk, bolstering the dollar forecast in the short term.

Oil prices surge amid uncertainty

Oil prices have been quick to react, rallying yesterday as news of Iran's missile preparations broke, and hovering around $75 per barrel. Traders are now waiting to see the scale of Israel's retaliation before making further moves. The dollar has strengthened in tandem with rising oil prices, as uncertainty continues to dominate the geopolitical landscape.

While oil typically surges during times of conflict, the dollar’s movement has followed a similar pattern, bolstered by its status as a safe-haven currency. However, if Israel's response remains contained, markets may interpret this as a sign that both sides are willing to de-escalate, easing the pressure on oil and stabilizing the dollar forecast. Still, with tensions this high, the situation remains fluid, and volatility is to be expected.

US data adds complexity to dollar forecast

Amid the geopolitical drama, domestic US economic data has been somewhat overshadowed but remains critical to the dollar forecast. Fed Chair Jerome Powell pushed back against the idea of another 50bp rate cut this year, with strong job openings data and a solid ADP private payrolls report supporting his hawkish stance. While manufacturing data was softer than expected, the labour market’s resilience keeps the dollar on a firm footing in as far as this week is concerned.

Friday’s payroll report will be a key event for FX markets, especially as traders balance geopolitical risk with domestic economic performance. Although markets are still pricing in more than 50 basis points of rate cuts by the year’s end, Powell’s recent remarks suggest the bar for a dollar-negative report is quite high. Before then, Thursday’s release of ISM services PMI and jobless claims figures could further complicate the dollar forecast as they offer additional clues on the health of the US economy and jobs market.

Dollar Index (DXY) technical analysis: levels to watch

Source: TradingView.com

The fact that the dollar index has broken above short-term resistance around the 101.00 handle suggests the short-term bearish trend has ended. However, the longer-term trend remains intact, but we will now need to see some stimulus to re-establish that bear trend. Perhaps, Friday’s jobs report could be the trigger, or potentially the outcome of US presidential election on November 5. From a purely technical point of view, the next potential resistance zone to watch is around 101.85, where recent highs meet the bearish trend line from June. Further higher, the area between 102.20 to 102.50 is going to be very important with the March low of 102.35 coming in bang in the middle of that range. The low in March was a significant one, and for as long as we remain below it, the dollar risks remain skewed to the downside in the near-term outlook despite the more recent gains this week.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R