US DOLLAR OUTLOOK:
- U.S. dollar ended the day lower despite the Fed’s hawkish monetary policy outlook
- The FOMC held rates steady at the end of its June meeting, but signaled the tightening cycle is not over
- The U.S. dollar’s bearish reaction suggests markets are skeptical of the Fed’s plans to resume hiking later this year
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The U.S. dollar, as measured by the DXY index, weakened on Wednesday despite the Federal Reserve’s aggressive stance. While the greenback initially advanced following today’s monetary policy announcement, it was unable to hold gains for long, a sign of a lack of confidence in the central bank's outlook.
For context, the FOMC held borrowing costs steady in a range of 5.00% to 5.25% at the end of its June meeting, but indicated that more work is needed to defeat inflation, with policymakers projecting a terminal rate of 5.6% for 2023, up from 5.1% previously. This would represent two additional 25 bp hikes over the next six months. By corollary, this means the “pause” would be short-lived.
The dollar's counterintuitive reaction suggests that markets are not convinced that the Fed will follow through with its plans to resume tightening later this year. If traders believed in the steeper normalization path and the message of “higher for longer”, implied yields on 2023 Fed fund futures would have repriced higher and stayed at those levels. The chart below shows that did not happen.
2023 FED FUNDS FUTURES IMPLIED YIELDS
Source: TradingView
For interest rate expectations to shift in a more hawkish direction, the macro landscape will have to validate the view that the economy remains in good shape to withstand a more restrictive monetary policy environment aimed at curbing inflation. To get a better understanding of the evolving outlook, traders should keep a close eye on upcoming economic reports, such as U.S. retail sales, unemployment claims and the consumer confidence survey.
If incoming statistics confirm that economic activity remains resilient, investors will be less hesitant to discount a more aggressive policy outlook. This could rekindle the U.S dollar's recovery. Conversely, if data begins to deteriorate, the market skepticism could be supported, reinforcing the U.S. dollar's subdued tone.
US DOLLAR TECHNICAL ANALYSIS
In terms of technical analysis, the U.S. dollar index has been trending lower since the beginning of the June following an unsuccessful attempt to clear trendline resistance at 104.55. That said, if prices retain their bearish bias and push lower, initial support stretches from 102.40 to 102.15. If this floor is taken out, we could see a move towards 101.50.
On the flip side, if buyers regain control of the market and spark a bullish reversal, the first ceiling to keep in mind rests at the psychological 104.00 level (also trendline resistance). If this barrier is breached, DXY will have fewer obstacles to reclaim 104.70, and then the 200-day SMA.
US DOLLAR (DXY) TECHNICAL CHART
