DXY preview: the index enjoys a September high

September is traditionally the best-performing month of the year for the USD index, the DXY, which has recorded an average gain of 1.44% over the past ten years.

September's USD performance

After its overnight rally, the DXY is already up 1.187% this September, having regained all the ground it lost into month-end and more. The driver of US dollar gains this week has been more of the same: higher US yields, signs of a deepening slowdown in Europe and China, which sparked risk aversion, and weakness in the Japanese yen.

Starting with the former, US yields climbed overnight, following a hotter-than-expected ISM Services PMI that contained worrying signs of pricing and employment pressures.

Defying market expectations for a fall to 52.4, the ISM Services PMI rose to 54.5 in August from 52.7 in July, its highest reading since February. The Prices paid sub-index increased to 58.9 from 56.8, and the employment component increased to 54.7 from 50.7.

In response to the ISM beat and hawkish comments from ECB official Klass Knot, who warned about the possibility of a rate hike from the ECB next week, US 2-year yields closed 6 basis points higher at 5.02%, up 25 basis points from Friday's low. The probability of a 25 basis point rate hike in November, which we have flagged in recent weeks as being underpriced, is back up to 44%.

Impact of US Yields, global slowdown, and USD strength

Turning to the slowdown in China and Europe, which continues to see their respective currencies marked lower against the greenback.

Earlier this week, a larger-than-expected drop in the Caixin Services PMI for August (51.8 vs. 53.6 expected) saw USD/CNY trade above the 7.3200 level for the first time in 10 months. A similar story in Europe. The final reading of the Euro Area composite PMI was lower than expected (46.7 vs. 47 expected), sending the EUR/USD to test support at 1.0700 for the first time in three months.

Topping it all off for the USD dollar index, USD/JPY rallied to a fresh cycle high of 147.87, its highest level in ten months, as yields on Japanese Government Bonds remain anchored around 0.65%, in contrast to the 4.29% on offer in US 10-year notes.

DXY technical analysis

In the first half of 2023, the US dollar index, the DXY, tested and held support at 101.00/80 on three separate occasions before declining after disappointing US inflation data released in mid-July.

As we've noted since late July, the rapid rebound above 101.00/80 revealed the mid-July 99.57 low as a false break lower. For followers of Elliott Wave theory, this is seen as a Wave V low, following the completion of a five-wave impulsive sequence from the September high of 114.78, as displayed on the chart below.

The recent rally from the 99.57 low to the high of 105.02 suggests that the DXY is now in overbought territory. After this period of DXY strength concludes, a pullback towards 102.00 is likely by year-end.

However, before that pullback, there's a possibility of the US dollar index, the DXY, extending gains towards the March 105.88 high. It's worth noting that the 50% retracement level of the five-wave decline from the October 114.78 high to the July 99.57 low is around 107.20.

In summary, despite the overbought condition, we can't dismiss the chance of further US dollar strength in September before a well-deserved pullback for the greenback begins.

DXY index daily chart

• _{TradingView: the figures stated are as of September 07, 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.}