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Talking Points:

- After the European Commission rejected the Italian government's budget proposal, Italian bond yields spiked and the Euro slumped, erasing progress made at the end of last week.

- The US bond market is closed for Columbus Day, which means liquidity conditions will weaken significantly once European markets close; this is the recipe for quiet trading conditions in the US afternoon session.

- Retail traders remain net-long EUR/USD and GBP/USD after the US Dollar's recent surge.

Looking for longer-term forecasts on the US Dollar? Check out the DailyFX Trading Guides.

The US Dollar (via the DXY Index) is trading back to the topside thanks to renewed pressure on the Italian government revolving around its budget proposal. Gains seen by the Euro and Italian bonds at the end of last week were wiped out, with EUR/USD hitting a fresh monthly low, the Italian FTSE MIB hitting its lowest level since February 2017, and the Italian BTP 10-year yield hitting its highest yield since February 2014.

In a week where the calendar is otherwise barren for the Euro, the Italian budgetary showdown will remain the most prominent catalyst. But the same can be said of the US Dollar, which is only looking at the September US Consumer Price Index at the end of the week. We know that the US Dollar has been moving on factors unrelated to Fed policy, and this should continue moving forward.

However, for today in particular, it looks as if the rest of the session should come down on the quieter side of things. If there has been one organic factor supporting the US Dollar, it has been the explosion higher in US Treasury yields in recent weeks; both the 10- and 30-year yields are at multi-year highs. But with the US bond market closed for the Columbus Day holiday, US yields aren't moving at all - which means the US Dollar is deprived of a key source of strength.

The closing of European financial markets for the day, coupled with the US bond market on holiday, means that trading conditions should be calmer until Asian markets reopen on Tuesday. In turn, because markets were deprived of US yields as a catalyst today while US stock markets were open, it seems highly likely that a gap open for US bonds on Tuesday is possible - which means that FX markets (particularly USD- and JPY-pairs) will see a bit more volatility than usual.

DXY Index Price Chart: Daily Timeframe (January to September 2018) (Chart 1)

DXY Index Holds Gains; Quiet Trading Expected with Bond Market Closed

From the technical perspective, the DXY Index continues to develop in a bullish manner. Despite closing lower on Thursday and Friday, the DXY Index was able to maintain a weekly close above 95.53, the level we've outlined as the Maginot line between neutral and bullish outlooks. With price still above its daily 8-, 13-, and 21-EMA envelope and the moving averages still in sequential order, bullish momentum remains strong. Both daily MACD and Slow Stochastics are continuing to trend higher above their respective median or neutral lines. For the first few days of the new week, the US Dollar's outlook remains bullish.

Read more: Weekly Fundamental Forecast: Dow Looks to Reconcile with Global Risk Trends, FX Markets Deal with Systemic Themes

FX TRADING RESOURCES

Whether you are a new or experienced trader, DailyFX has multiple resources available to help you: an indicator for monitoring trader sentiment; quarterly trading forecasts; analytical and educational webinars held daily; trading guides to help you improve trading performance, and even one for those who are new to FX trading.

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

Follow him on Twitter at @CVecchioFX