USD: Dollar gains momentum ahead of all-important CPI report

US dollar strength steals the spotlight

The central theme across FX markets this week in the lead-up to tonight’s US inflation report has been the strength of the US dollar. The US Dollar index, the DXY, is up 0.5% for the week and, pending the outcome of tonight’s inflation figure, is on track for a fourth consecutive week of gains.

Despite expectations that tonight’s US inflation figure will be well-behaved, which would usually weigh on the greenback, the US dollar has found support through safe-haven buying following weak Chinese data and Moody’s downgrade of several US banks.

Surging energy prices: A new disruptive force

As one concern recedes, another emerges. While the bond market is indicating growing comfort with increased supply, surging energy prices are quickly becoming the new focal point, raising the possibility of disrupting the disinflation/soft landing narrative.

Overnight European gas prices surged by 30%, and the relentless climb in crude oil prices resulted in WTI crude oil closing at a nine-month high, above $84.00 per barrel. Considering the recent surge in energy prices, a higher-than-expected inflation figure tonight will likely be met with more apprehension, potentially leading the market to downplay a softer inflation reading.

What is expected?

Last month, the headline Consumer Price Index (CPI) in the US decelerated to 3%, marking the lowest level in two years, down from 4.0% in May. The Core CPI, which excludes volatile items, eased to 4.8%, marking the lowest rate since October 2021, down from 5.3% in May.

For this month, both the headline and core CPI are forecasted to rise by 0.2% on a month-on-month basis. This projection would result in the headline rate edging higher to 3.3% on a year-on-year basis, while core inflation is anticipated to remain stable at 4.8%. The range of estimates for headline inflation spans from 3.5% to 3.1% on a year-on-year basis.

Scenario analysis

1. If headline inflation prints at 3.5% YoY or higher, US yields and the US dollar will surge as the bond market vigilantes return to centre stage. The S&P500 will likely need to reacquaint itself with 4400
2. If headline inflation prints between 3.2% and 3.4%, it will likely see the Fed on hold in September and allow other factors to drive the narrative in bond and equity markets. The US dollar should continue to outperform, supported by higher energy prices
3. If headline inflation prints at 3.1% or lower, US yields will likely ease further from last week's highs. US equities will gain, with the S&P500 likely to retake 4550 in the sessions ahead. The US dollar will likely ease, particularly against the antipodean currency pairs.

DXY technical analysis

During the first half of 2023, the DXY tested and held support at 101.00/80 on three separate occasions before declining further after last month's softer-than-expected inflation data.

As we have highlighted in recent updates that the swift rebound back above 101.00/80 left the post-CPI sell-off at the 99.57 low, exposed as a false break lower. For followers of Elliott Wave, this is viewed as Wave V low, following the completion of a five-wave impulsive sequence from the 114.78 September high, as seen on the chart below.

With the DXY building acceptance this week above resistance at 102.00, we are becoming more confident that the wave count on the chart below is correct, and we anticipate a more robust recovery towards trend line resistance and the 200-day moving average in the 103.50 area.

Should the DXY index experience a sustained break above resistance at 103.50ish, the next upside levels are the May 104.69 high, followed by year-to-date highs at 105.88.

DXY daily chart

• _{TradingView: the figures stated are as of August 10, 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.}