Knotting the surge: How BoJ, ECB and US CPI could impact the US dollar

US dollar's September rally

So far this month, the US dollar has followed the plan, rallying +1.5%, in line with its ten-year average for September of +1.44%, before trimming gains at the start of this week.

The catalyst for the pullback in the dollar was Bank of Japan (BoJ) Governor Ueda, who noted over the weekend that the BoJ may take its next step towards policy normalization before year-end, along with incrementally better news and data from China.

Adding to the dollar's retreat, there is a desire to lock in profits on US dollar longs ahead of tonight's US Consumer Price Index (CPI) and tomorrow night's European Central Bank (ECB) meeting.

ECB's warning and dollar retreat

Raising the stakes, the warning shot fired by ECB's Knot last week has been reinforced. Knot said markets were underestimating the chance of an ECB rate hike. Headlines at about 7.30 am AEST today noted that the ECB expected Euro Zone inflation to remain above 3% next year, which has seen the chances of a 25bp rate hike from the ECB on Thursday increase from about 35% to 55%.

If US CPI prints in line (see below) and the ECB were to raise rates and sound hawkish, it could, in effect, see a 'Knot' tied around the US dollar into year-end.

US CPI technical analysis

Scenario analysis using core CPI

• Scenario 1: Core CPI YoY prints at 4.5% or higher

This would imply that core inflation remains stickier than expected. It would likely see the rates market price in a 40-50% chance of a Federal Reserve Bank (Fed) hike in September and a 65-75% chance of a Fed rate hike in November. The DXY, will surge.

• Scenario 2: Core CPI YoY prints in line at 4.3%

This would reinforce the current Goldilocks ‘not too hot, not too cold’ narrative around the US economy. It will keep the Fed on hold in September and, likely, in November as well - business as usual for the DXY.

• Scenario 3: Core CPI YoY prints at 4.2% or lower

This would see the rates market jump for joy as it embraces the likely end of the Feds rate hiking cycle. Profit-taking would see the DXY slump by 1.5%.

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 following softer-than-expected inflation data in mid-July.

As we've highlighted since late July here, the swift rebound back above 101.00/80 left the mid-July 99.57 low exposed as a false break lower. For followers of Elliott Wave, this was viewed as a Wave V low, following the completion of a five-wave impulsive sequence from the 114.78 September high, as seen on the chart below.

The subsequent rally from the 99.57 low to last week's 105.15 is considered the first wave (Wave A) of a corrective rally. Once the current period of DXY strength has run its course, a pullback (Wave B) towards the 200-day moving average at 103.00 is likely.

However, before that pullback (Wave B) commences and given the event risk this week, there's a possibility that the DXY could extend gains towards the March 105.88 high and beyond before reversing lower.

In summary, we believe that the rally in the DXY is nearing completion, and the greenback is not too far away from a well-earned pullback.

DXY daily chart

• _{TradingView: the figures stated are as of 13 September 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.}