The US Dollar (USD) consolidates with lower highs and higher lows after the volatility pickup earlier this week. Traders are left clueless ahead of the first US Federal Reserve meeting to be held next week. Although it becomes clear no rate cut will take place, traders have only delayed their rate-cut expectations until May, (from March), which makes it difficult for the Greenback to rally substantially.
On the economic front, there is only one element that might push the US Dollar in either way, which is the University of Michigan Consumer Sentiment Index for January, together with inflation expectations. As seen earlier this week with some soft indicators like the NY Empire Manufacturing Index and the Philadelphia Manufacturing number all remaining very weak, a contraction in the Michigan Sentiment number could make traders push forward March again for an initial rate cut from the Fed.
The US Dollar Index (DXY) is caught between a rock and a hard place on the charts. Although the moves earlier this week looked bullish, it makes sense that the US Dollar was unable to steam away and perform a substantial rally on the DXY chart. Reason for that is that traders only have rebalanced their bets for an initial rate cut by the Fed from March to June, which indeed asks for some higher valuation of the US Dollar, though possibly not enough to move away from the 55-day and the 200-day Simple Moving Averages (SMA) near 103.33 and 103.46 respectively.
The DXY is trading smack in the middle of those two moving averages this Friday. In case the DXY can get through that area again and run away, look for 104.44 as the first resistance level on the upside, in the form of the 100-day SMA. If that gets scattered as well, nothing will hold the DXY from heading to either 105.88 or 107.20, the high of September.
Risk of a bull trap is still a possible outcome, where US Dollar bulls were caught buying into the Greenback when it broke above both the 55-day and the 200-day SMA in early Wednesday trading. Price action could decline substantially and force US Dollar bulls to sell their positions at a loss. This would see the DXY first drop to 102.60, at the ascending trend line from September. Once threading below it, the downturn is open to head to 102.00.
The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022.
Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.
The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates.
When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.
In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system.
It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.
Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.