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US Dollar Index Analysis
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After hitting an intra-day high of 94.561 earlier this week, the dollar index (DXY) has fallen back towards the 94.000 level following yesterday’s sell-off. On the back of yesterday’s release of US CPI data and FOMC minutes from the Federal Open Market Committee meeting on September 22nd, the US dollar was unable push beyond the $94.50 resistance level.
Expectation of a Fed rate hike are increasing, leading to an increase in short end yields in the US. The US dollar’s failure to benefit from the hike in short-term yields may be due to a growing concern over the US growth outlook as we have seen GDPNow data showing a fall in productivity, or it may just reflect the overall reversal in positioning following the recent heavy sell-off in bonds. The fiscal flows released last night show that we are on target for a $540 billion monthly spend into the economy this month, which is like pre-pandemic levels; with the difference being, spending is slowing, and we have an equities markets still around all-time highs, even with the recent correction.
The Fed’s tapering will likely begin in mid-November or mid-December and should be completed by the middle of next year. This could show up also in the reverse repo data as I assume we will have more spending and debt issuance from the US treasury, but the Fed will be removing less out of the markets. The reserve drains of issuing new debt should then allow banks to lend more but we will have to wait for that data to see if more bank credit growth fills in the gaps of a reduced fiscal flow.
There will be a monthly reduction of $10 billion for Treasury securities and $5 billion for agency mortgage-backed securities in the pace of asset purchases under the plan. Then the Fed may decide to begin raising rates in 2H 2022. The rest of the world are starting to go into a rate hike cycle and if the Fed to raise the Fed Fund Rate, we should expect the yields to rise, and this could be near-term supportive of the US dollar as the perception is that rate differentials will benefit the US dollar. The Fred graph above shows that the short end of the curve follows very closely to the Fed Funds Rate. With the longer-term rates drifting towards the FFR.
For me though it is all about confidence in the US administration, the fiscal flows that they generate, and whether the corporations can be continued to be supported. The US dollar has pressure from the widening deficit spending and the widening trade balance data, so a rate hike may also act against the US dollar long term under these conditions.
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A break below the $93.67 this week will be a bearish signal on the US dollar index, as that will be a bearish outside week. Assuming we close red for the week. $93.65 is also a pivot level which has in recent history been resistance and then support. A break below and we could have that level acting as resistance again. Until then we have to assume that yesterday was profit taking in the US dollar as we’re still technically in a bull trend. If today’s Initial Jobless Claims and PPI data comes out weaker than expected the dollar could be in for a rough ride lower.
