It has been a good week for the US dollar, although the greenback was losing a bit of momentum at the time of writing at the European morning session on Friday, states Fawad Razaqzada of Trading Candles.
Traders awaited fresh comments from Powell, who would be participating in a panel discussion titled "Perspectives on Monetary Policy" later in the day. Fed’s Williams and Bowman are also scheduled to speak. With the lack of any other major catalysts, it remains to be seen whether the dollar index will fall back meaningfully or remain supported heading into the weekend when a deal on the US debt ceiling is expected to be announced. For what it is worth, I am expecting renewed weakness to creep back into the dollar.
Inflation has peaked in the US, yet policymakers continue to err on the side of caution. In the eyes of the Fed, the US economy has not cooled sufficiently enough to warrant a pivot just yet, although that hasn’t stopped the market from betting over a couple of rate cuts before the end of 2023. Those bets were trimmed somewhat following some hawkish comments by Fed's Logan and the release of lower-than-expected jobless claims data. The odds of a 25-basis point September rate cut have dropped to 24% from around 50% about a week ago. Meanwhile, the odds of a June rate hike, while still low, have been climbing to stand around 36% as of Friday.
Dollar Upside Potential Limited
I expect the dollar to weaken again, for the optimism surrounding the US debt deal has not filtered through the more risk-sensitive foreign currencies yet. If you look at the rallying global equity markets, investors are very optimistic about the US debt ceiling negotiations and not too worried about the slowdown in China. Yet, the same optimism is not evidenced in commodity dollars or emerging market currencies.
On Friday morning, the German DAX index rallied again and was set for a record closing high. Easing worries over US debt-ceiling talks, as well as stronger corporate earnings and falling energy prices have all helped to fuel the rally. But it is not just Germany or indeed Europe, where equities are rising. Look no further than Japan, where the Nikkei has been on a tear, rising 17% from its March low to break the September 2021 peak overnight. Despite Japan’s CPI rising to a 42-year high, the BOJ is happy to main an ultra-easy policy stance, which is helping to provide support for Japanese stocks. We have also seen a big rally for the Nasdaq 100 this week, lifting the tech-heavy index to its best level since last April.
Yet unlike these equity indices, the FX markets are not so cheerful. Admittedly, the JPY crosses have been on a tear along with the Japanese equity markets to suggest it is indeed “risk-on”. But if you look at the US dollar against other currencies, you will get a different picture – for it has also risen against the more risk-sensitive AUD, GBP, EUR, etc.
In the US, interest rates are already at a peak and inflation is on a downward trajectory. There is a possibility that the economy is going to weaken in the months ahead, allowing the Fed to pivot by as early as September.
In the short-term, the potential weakness for USD could arise from a potential rebound in foreign currencies, should improving risk appetite make its way into risk-sensitive currencies. President Joe Biden and House Speaker Kevin McCarthy’s rhetoric have narrowed, and both are optimistic about achieving a deal by Sunday. If so, expect the week ahead to be overall dollar-negative, as racier currencies find support.
Global PMIs Could Impact Sentiment
Tuesday, 23 May
Global demand concerns have dragged on sentiment toward commodity and risk-sensitive FX pairs in recent weeks, following the release of several disappointing data pointers from China and Europe. This puts next week’s PMI into focus as they provide a leading indicator of economic health. This is because businesses tend to react quickly to market conditions, which means their purchasing managers are likely to hold the most current insight into the economy.
Given the recent weakness observed in Chinese and Eurozone data, the best pairs to watch are the USD/CNH and EUR/USD. If the latter moves back above 1.0850, this will reinstate the bullish technical trend.
RBNZ Rate Hike Priced In
Wednesday, 24 May
This could potentially be the rate last hike of the RBNZ’s tightening cycle. The sharp drop in inflation expectations means the central bank is likely to lift rates by a 25bp increment this time to lift the OCR to 5.5%. This is fully priced in, meaning the NZD’s reaction will depend on how hawkish or dovish the central bank will be in its rate statement or the quarterly monetary policy statement. Watch out for upgrades to forecasts in CPI and GDP.
UK CPI Seen Falling Below 10% Finally
Wednesday, 24 May
UK CPI inflation is seen falling relatively rapidly from here on, after remaining stubbornly high above 10% for several months. This is because the past big rises in CPI will start falling out of the year-over-year comparison. In March, CPI eased only modestly to remain above the 10% mark for the seventh consecutive time, disappointing expectations. At five times above the Bank of England's 2% target, inflation is simply too high for policymakers to relax just yet. A move back above 1.25 would put the GBP/USD on a hawkish path.
Core PCE Could Make or Break Gold
Friday, 26 May
Inflation has peaked in the US, yet policymakers continue to err on the side of caution. The odds of a June rate hike are low, but they have been climbing to stand around 36% as of last Friday. This is because of continued hawkish rhetoric from Fed officials, as well as a surprisingly strong labor market. In the eyes of the Fed, the US economy has not cooled sufficiently enough to warrant a pivot just yet, although that hasn’t stopped the market from betting over a couple of rate cuts before the end of 2023.
A weaker print therefore could send the dollar lower and lift gold. A rise back above the $2K handle is needed now to signal the resumption of the bullish trend for XAUUSD.
To learn more about Fawad Razaqzada visit TradingCandles.com.