FX Watch: US Dollar Index on watch ahead of US PCE data

US Dollar attempting to stabilise in the near term

After a touch of its 14-month low, the US dollar is attempting to stabilise in the near term after buyers stepped in to defend its key psychological 100.00 level to end last week. Despite an outsized 50 basis point (bp) cut this month to the 4.75%-5% range, the Federal Reserve (Fed) has opted for a more conservative rate path ahead (4.4% Fed rate by year-end). This likely point to a 25 bp cut in November, followed by a similar move in December.

That view has been met with some scepticism by markets however. The rates market continues to price for a more dovish 75 bp worth of cuts by the end of this year, with the misalignment in expectations between policymakers and market participants likely to leave sentiments highly sensitive to upcoming economic data ahead for some recalibration from either side.

US core Personal Consumption Expenditures (PCE) price data in focus this week

At the recent Fed meeting, Fed Chair Jerome Powell has seemingly declared victory on the inflation fight, saying that upside risks to inflation has “diminished”. Policymakers have now clearly shifted their focus to supporting the labour market and to ensure that a soft landing is achieved.

Thus far, headline and core PCE data have not been much of an issue for the Fed. Although inflation remains above the Fed’s target, markets are convinced that the broader disinflation trend will continue to play out. Ahead, core PCE is expected to remain unchanged at 0.2% month-on-month, while headline PCE may ease to 0.1% month-on-month versus the 0.2% prior. Components in the consumer price index (CPI) and producer price index (PPI) data that feed into PCE have also earlier suggested broad pricing pressures under control.

US Dollar Outlook: Broader downward bias likely to remain

While we have seen some bearish sentiments unwind in the US dollar lately, we believe the broader downward bias may remain due to the following reasons.

1. The Commodity Futures Trading Commission (CFTC) data shows that aggregate US dollar positioning versus other G10 currencies remained in net-short territory for the fourth consecutive week. While there is some slight paring of short positions over the past weeks, recovery in the US dollar thus far has been short-lived.

2. Seasonality over the past 50 years suggests that weakness in the US dollar may potentially drag till mid-October. While there may be a slight recovery going into November, the US dollar may generally revert to its seasonal decline as the end of the year approaches (mid-November to end-December).

3. Lower Treasury yields may remain a drag on the dollar. The US 10-year Treasury yields (weekly chart) have broken below a head-and-shoulder neckline in August this year, with room for further downside based on the pattern’s price target projection. Past instances of yield curve steepening, which is in effect now, have also seen a weaker US dollar.

4. On the technical front, its daily relative strength index (RSI) continues to trade below its mid-line, along with various trend indicators (daily Ichimoku Cloud, 50-day, 100-day, 200-day moving averages (MA)).

Strategy: A long-tailed daily candlestick suggests some dip-buying on 18 September, with a subsequent retest of the key psychological 100.00 level met with some defending from buyers as well. This suggests room for the US dollar to stabilise near-term. However, trading in line with the broader downward trend may leave one to watch for any sell-the-bounce opportunity, with a resistance confluence likely to be presented at the 102.00 level.

Levels:
R2: 103.40
R1: 102.00

S1: 100.40
S2: 99.12