US dollar fizzles amid rate hike pauses and central bank divergences

After a fiery display of strength in May, the US dollar's flame appears to be dwindling as June is marked by three consecutive weeks of declines.

The US dollar index, the DXY’s decline in June accelerated last Thursday after the Fed paused its rate hiking cycle at 5.0-5.25% while the ECB raised its deposit rate overnight by 25bp to 3.50% and endorsed market pricing of another 25bp rate hike in July.

Whether the US dollar index, which includes a 57% weighing of the euro, will continue to depreciate under the weight of central bank divergence is debatable. The ECB is expected to raise rates by a further 25bp in July to 3.75%, with the possibility of one final 25bp rate hike before year-end, taking the deposit rate to 4%.

As the Fed’s new dot plots showed last week, members expect at least another 50bp of rate hikes this year, taking the Feds Funds into a range of 5.5% to 5.75%. The rates market is pricing in a 76% chance of another 25bp rate hike but only assigning a 12% probability of a second-rate hike.

Fed Chair Powell may choose to lean against this dovish pricing when he delivers his semi-annual congressional testimony before the House Financial Services Committee at midnight tonight AEST.

Awaiting Powell's guidance

In the post-meeting press conference following last week's FOMC meeting, Fed Chair Powell emphasised that the upward shift in the Fed's dots was predominantly a response to heightened core inflation. However, he was quick to downplay these projections, underscoring the Fed's commitment to data-dependency.

The efficacy of a "pause" or "skip" in rate adjustments, as recently demonstrated by the RBA and BoC, hinges significantly on the subsequent cooling of data. Yet, this poses a notable question as the recent housing starts and building permit data for May exhibited minimal signs of cooling, indicating the continued resilience of the economy.

Housing statistics surged 21.7% m/m to 1.63 million, the largest increase since October 2016 and building permits rose by 5.2% m/m vs 0.6% expected. Both numbers suggest that the housing market is recovering from last year’s weakness as the underlying economy remains resilient.

DXY technical analysis

In 2023, the US dollar index, the DXY, tested and held support at 101.00/80 on three separate occasions before bouncing to a high of 104.69 in May.

While the weakness from the May 104.69 high has been disappointing, it likely confirms the DXY is set for further range trading between support at 101.00/100.75 and resistance 104.69 /105.20 coming from the May highs and the 200-day moving average.

Aware that if support at 101.00/100.75 were to break on a sustained basis, it would likely see a test of support at 97.00.

DXY daily chart

• _{TradingView: the figures stated are as of June 21, 2023. Past performance is not a reliable indicator of future performance. This report does not contain and is not to be taken as containing any financial product advice or financial product recommendation.}