Dollar Weak - But Has it Peaked?

The dollar’s done for, inflation has peaked, and there’s still hope of a soft landing for the global economy. That narrative might not be true, but It’s certainly picked up some fans lately. So, has the dollar topped, or is this a false dawn before the storm hits?

EURUSD has been on a good run of late. Far better than the period from February to September, where the single currency declined from 1.15 to 0.95, as shown in the channel below:

Over the past two months, the dollar has weakened significantly, with EURUSD retracing 50% of the down cycle, and reclaiming the 200 day moving average. However, the trend change is not confirmed by the slope of the moving average.

As a general guide, a rising long-term average (such as the 100 or 200 day) is considered a stronger support than a flat or declining line. Price trading above the average is just the first step, it doesn’t always mean that the trend has changed! Nevertheless it can provide a clue that a pullback is mature.

Looking across the major pairs, a similar pattern is obvious. Dollar strength has given way, leading to a deep pullback and a retest of the 200 day moving averages.

Take a look at USDJPY:

Notably, the moving average continues to trend higher, and support was found for the USD right on the 200DMA. For the much-maligned GBPUSD, we see a similar pattern to the euro:

The synchronicity suggests that this is far more about the USD than any of the individual currencies on the other side of these pairs.

__So, what happens next? __

The crystal ball’s on the blink right now, but there are some key catalysts to watch closely next week. First up, the US CPI number on Tuesday. If this data comes in below expectations, it could further embolden USD sellers. Likewise, if inflation ticks higher again, it could pour cold water on the idea that the Fed tightening is almost over.

The following day, the Federal Reserve is expected to hike by 0.5% and also release their economic projections, including interest rate forecasts (the dot plot) for 2023 and beyond.

Higher interest rates for longer could be supportive of the dollar again, although it may be harder to establish a solid trend.

Bank of America strategists see the risks as more balanced for the year ahead:

We expect modest USD downside by the end of 2023, continuing into 2024. However, on all of these fronts, we are not out of the woods yet. US inflation remains very high, and we are concerned it will be sticky on the way down.

We expect the Fed to remain hawkish until inflation is well along towards its target. Our economists expect the Fed to hike by an additional 125bp cumulatively by March, although they also expect the US to be in recession for most of 2023. The risk is for an even higher terminal rate if inflation does not drop fast enough, which would imply a stronger USD near term.

Inflation, and the central bank response look likely to be a key driver for the USD for some time yet.