The Fed Wrestles with Rate Expectations as USD Bulls Continue Push

US Dollar, Federal Reserve Talking Points:

• The US Dollar has continued to show strength after the first half of the year was largely consolidative.
• USD bulls have awoken since the start of the second half of the year. With rate hikes potentially finished in Europe and the UK, this exposes the US as one of the economies still driving forward with hawkish monetary policy and that could keep the US Dollar on the move through Q4. Markets are currently assigning an approximate 40% probability to one more hike this year, with cuts expected to begin next year.
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The US Dollar bullish theme has continued to run and the September FOMC rate decision seemed to do little to tame that trend. While the Fed is still forecasting rate cuts for 2024, they moderated their prior expectation from four cuts down to two, and with US economic data continuing to show strength there’s been a growing deviation between the United States economy and the rest of the world.

Recent rate decisions in Europe and the UK give the appearance that central banks in those economies may be finished with rate hikes for this cycle. Collectively, that’s amounted to weakness in both currencies and that brings a deductive drive of strength to the DXY as the Euro is 57.6% of the DXY quote and the British Pound is 11.9%.

At this point the US Dollar is nearing the 2023 high that was set in March of this year. Prices in DXY went into a sell-off shortly after that high was set earlier in the year as regional banks in the US started to show signs of crisis, and this caused markets to downgrade rate hike expectations around the FOMC, driven by the thought that the bank wouldn’t risk more damage to the banking sector. But six months later with US data retaining strength, and with data in Europe and the UK slowing down, the DXY is back above the 105 handle and this carries breakout potential into the fourth quarter of this year.

US Dollar - DXY Daily Price Chart (indicative only, not available on Forex.com platforms)

Chart prepared by James Stanley; data derived from Tradingview

US Dollar Bigger Picture

The big question at this point is whether this recent resurgence of US Dollar strength brings back the bullish trend that ran so strong through 2021 and the first nine months of 2022. That trend was very much driven by rate expectation as US inflation had climbed to the point where the Fed could no longer dismiss it.

It was around the Q4 open of 2022 when matters began to shift, and this was supported by two different important facts:  US inflation had begun to slow, bringing with it softer expectations for future rate moves from the Fed. But, also important was the fact that other central banks, namely the European Central Bank, began hiking rates more aggressively to temper their own inflationary concerns. That helped to bring a reversal into that previously bullish trend in the US Dollar through the fourth quarter of last year, and that weakness in the Dollar (and strength in EUR/USD) held through the open of this year.

From the US Dollar weekly chart below, we can see that consolidation that built through the first half of 2023 trade, and we can see it taking the form of a bearish bias. This built into a formation called a falling wedge, which is often approached with the aim of bullish reversal.

For the past six weeks, that’s been what’s happened as USD bulls have continued to push higher.

US Dollar - DXY Weekly Price Chart (indicative only, not available on Forex.com platforms)

--- written by James Stanley, Senior Strategist