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US Dollar Drops as Fed Beefs Up Backstop, FX Volatility Ebbs

US Dollar Drops as Fed Beefs Up Backstop, FX Volatility Ebbs

Rich Dvorak, Analyst

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US DOLLAR FORECAST: US DOLLAR EDGES LOWER AS THE FED DOUBLES DOWN ON STIMULUS EFFORTS, FX VOLATILITY PULLS BACK

The US Dollar is starting to pull back after soaring nearly 9% over the last two weeks. An astounding rise in the US Dollar Index since March 09 came on the back of risk-off sentiment and corresponding demand for safe-haven assets – like the US Dollar – due to the worsening coronavirus pandemic.

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After unprecedented news released by the Federal Reserve yesterday, however, the US Dollar has begun to give back recent upside. The expanded Fed arsenal, like open-ended QE and allowing the FOMC to purchase US investment grade corporate bonds, has potential to weigh negatively on USD price action and broader US Dollar Index.

US DOLLAR INDEX PRICE CHART: 4-HOUR TIME FRAME (MARCH 05 TO MARCH 24, 2020)

USD Price Chart US Dollar Forecast DXY Index

Chart created by @RichDvorakFX with TradingView

That said, there could be a USD unwind underway with the US Dollar starting to experience modest weakness since its recent surge to three-year highs. The US Dollar pullback has held technical support provided by the 34-day exponential moving average and 23.6% Fibonacci retracement level of its latest bullish leg so far. This might suggest that the strong uptrend remains intact despite short-term downside.

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FED BALANCE SHEET EXPLODES AS FOMC ACCELERATES ASSET PURCHASES

Fed Balance Sheet Chart Federal Reserve Total Assets

As the Federal Reserve beefs up its liquidity backstop and efforts to counter financial market distress, which stems from market panic in response to the coronavirus pandemic, the Fed balance sheet has started to explode. Total assets held by the Federal Reserve will likely balloon even further after the FOMC stated yesterday it will purchase US Treasuries and agency mortgage-backed securities “in the amounts needed.” This stands to increase bank reserves, liquidity and supply of US Dollars circulating the financial system, which might serve as a headwind to USD price action.

FX VOLATILITY RECEDES FROM RECORD HIGH DESPITE DEEPENING CORONAVIRUS PANDEMIC

US Dollar Price Chart USD Forecast FX Volatility Coronavirus

Chart created by @RichDvorakFX with TradingView

FX volatility is another major fundamental theme driving the direction of the US Dollar. Expected currency volatility in the Euro, Pound Sterling and Yen over the next 30-days has started to fall from extreme highs. This suggests that perceived risk, or uncertainty, surrounding these major currency pairs is starting to recede while market angst surrounding the coronavirus pandemic calms.

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As market sentiment begins to improve and volatility drifts lower, largely due to hope that the flood of monetary and fiscal stimulus will offset economic fallout from the coronavirus, the US Dollar could continue its retracement lower. On the other hand, risk aversion and measures of volatility might snap back in an abrupt and aggressive fashion, which might slingshot the US Dollar to fresh year-to-date highs.

Read More: Gold Price to Resume Ascent as Fed Asset Purchases Balloon

-- Written by Rich Dvorak, Junior Analyst for DailyFX.com

Connect with @RichDvorakFX on Twitter for real-time market insight

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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