Trade Of The Week: Can Fed Satisfy Dollar Bulls?

The phrase “what goes up must eventually come down” springs to mind when looking at the dollar’s performance over the last few days.

We have seen the king of currency space loosen some grip on the FX throne thanks to a combination of profit-taking and reduced bets over how aggressive the Fed will be when raising rates this month. Appetite for the world’s most liquid currency has also been dampened by the improving market mood and recent fall in Treasury yields.

To be fair, the mighty dollar still has a domineering presence and this can be reflected in the month-to-date gains against most G10 currencies. However, the fuel could be running low for dollar bulls with a fresh fundamental spark needed to not only fill up the tank but keep the engines running at maximum speed.

Taking a brief look at the equally weighted dollar index, prices are under pressure on the H4 charts with bears eyeing the 1.1700 support.

After ruling over the FX arena since the start of 2022, are dollar bulls throwing in the towel or just taking a short break? It may be too early to answer this question due to the various fundamental forces at play. However, the dollar’s reaction to the Fed meeting on Wednesday and economic data this week could offer some fresh insight.

The low down…

The dollar got no love last week thanks to the risk-on mood and easing in longer-term inflation expectations.

In mid-July, there was a lot of chatter around the Federal Reserve potentially raising benchmark interest rates by a whopping 100 basis points to tame inflation. The drop in consumer inflation expectations for July trimmed expectations around the Fed making such a move. According to Bloomberg, the probability of a 100-basis point rate hike this month stands at 10%, as of writing.

This development could add more flavour and spice to the upcoming Federal Reserve meeting. The dollar’s weakness to the reduced bets of aggressive hikes continues to highlight how the currency remains highly sensitive to rate hike expectations.

The week ahead… 

It's all about the Federal Reserve meeting on Wednesday.

The central bank is widely to raise interest rates by 75 basis points for a second straight meeting but the main focus will be directed toward Fed Chair Jerome Powell’s post-meeting conference. Given how markets remain highly reactive to anything relating to inflation, interest rates, and growth – Powell's every word will be closely scrutinized. To prevent any unnecessary fireworks, he is expected to pledge the Fed’s resolve to vanquish inflation while putting growth into consideration.

Interestingly, the U.S economy is holding steady so far and the latest employment numbers look encouraging despite recession fears. However, the inflation picture remains gloomy with consumer prices (CPI), jumping 9.1% in June from a year earlier. On the bright side, the Federal Reserve’s preferred gauge of inflation declined to 4.7% in May.

Possible outcomes to Fed meeting 

• Fed hikes rates by 75-basis point. This decision may not be enough for dollar bulls since it has already been priced in. Such a move needs to be complemented by a firmly hawkish Powell which fuels speculation around more aggressive hikes down the road.
• Fed surprises markets with a 50-basis point hike. A smaller than expected hike is likely to trigger a sharp dollar selloff. If Powell adopts a cautious stance, this will add insult to injury – weakening the dollar further.
• Fed fires 100 basis point bazooka. This could send the dollar surging higher in the short term but gains may be surrendered by renewed fears of a US recession.

On the data front, it will be wise to keep an eye out on the latest consumer confidence report for July, US Q2 GDP, weekly jobless claims, and the PCE core deflator among other key economic reports.

Time for USD bears to dominate the scene?

Earlier we spoke about “what goes up must eventually come down”.

Well, this looks like the case with the equally-weighted USD Index on the weekly. After punching above 1.2150 back in mid-July, prices have been on a slippery decline. The weekly bullish trend is under threat with a strong breakdown below the 1.1700 higher low bringing bears into the game.

On the daily charts, prices are trading within a wide range with support at 1.1700 and resistance at 1.1950. There is still some hope for bulls given how the candlesticks are above the 50, 100, and 200-day Simple Moving Average. However, a daily close below 1.1700 could inspire a decline towards 1.1630 and 1.1450, respectively.

Federal Reserve USD Rates inflation