US dollar: DXY surge & Fitch downgrade's impact on US economy

Fitch downgrades United States' credit rating

The US dollar Index, the DXY, experienced continued recovery overnight, as US yields escalated despite weaker economic data. In a move that the US dollar has capitalised on today, ratings agency Fitch downgraded the United States’ long-term credit ratings from AAA to AA+ post the US equity and bond market closure, at approximately 7.15 am this morning AEST.

The warning signs of a potential downgrade surfaced in May as debt ceiling negotiations remained stagnant. Today, Fitch justified its decision by citing a consistent deterioration of governance and "a high and growing general government debt burden."

Implications of Fitch's downgrade and data indicators.

While this move is not predicted to have a lasting impact on asset prices in the near term, it has triggered a mild bout of risk aversion today. This response is influenced by the overnight pullback in equities and weak China PMI and ISM data. Within the ISM data, which increased slightly to 46.4 in July (from 46 in June) for the ninth consecutive month in contractionary territory, the Employment subindex declined to 44 from 48.1 in June.

The reduction in the ISM Employment component, which suggests potential job cuts, was supported by the drop in JOLTS Job openings to 9.582m - their lowest level in two years. This data sets the scene for this Friday's Non-Farm Payrolls data.

What to expect from non-farm payrolls

During the FOMC meeting last week, Fed Chair Jerome Powell indicated that some cooling in the labour market is necessary to manage inflation.

Market predictions for non-farm payrolls suggest an increase by 200k in July, compared to the previous month’s 209k. The unemployment rate is expected to remain at 3.6%, while wage growth is projected to slightly decrease to 0.3% MoM compared to 0.4% in June. This decrease would result in the annual rate easing to 4.2% YoY from 4.4%.

DXY technical analysis

In the first half of 2023, the DXY tested and maintained support at 101.00/80 on three separate occasions before dipping lower due to last month’s softer-than-expected inflation data.

As we highlighted in our update last week, the swift rebound back above 101.00/80 revealed the post-CPI sell-off to the 99.57 low as a false break lower. For those adhering to Elliott Wave, this is perceived as Wave V low, following the completion of a five-wave impulsive sequence from the 114.78 September high, as illustrated on the chart below.

With the DXY making gains over the past 24 hours, it is now meeting resistance at 102.00/40. A sustained break above (two consecutive daily closes) would significantly enhance the probability that the wave count on the chart below is accurate.

In such a scenario, we anticipate a stronger recovery towards trend line resistance and the 200-day moving average at the 103.65/85 area. Should the DXY index then surpass resistance at 103.65/85, the next upside levels are the May high of 104.69, followed by year-to-date highs at 105.88.

DXY daily chart

• _{TradingView: the figures stated are as of August 2, 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.}