Unexpected Dollar Rally with a Possible Swift Correction

The U.S. Dollar index (DXY) surged by 0.5% to reach 104.84 this week, marking its highest reading since February 14. In contrast, the EURUSD experienced a decline of 0.5%, falling to 1.07240. This unexpected rise in the Dollar followed a report of slowing inflation published the previous Friday.

Despite expectations of a weaker Dollar, the WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU) reported net capital outflows of $3.9 million after maintaining a near-zero balance for two consecutive weeks. This indicates that bets on a weaker Dollar have begun to emerge. However, U.S. 10-year Treasuries yields surged on Monday to 4.33% from 4.20% following the release of strong PMI data. The ISM Manufacturing PMI exceeded the 50.0 threshold for the first time in 16 months, with an actual reading of 50.3 points surpassing the forecast of 48.5 points. Additionally, the Atlanta Federal Reserve (Fed) GDPNow forecasted a Q1 2024 GDP growth of 2.8% QoQ, well above the previous estimate of 2.3%.

These positive developments led to a decline in bets on a Fed interest rate cut in June, which fell to 56.3% from 66.0%. However, the volatility in the currency market is increasing, and the Dollar's momentum may falter soon. The Bank of Japan (BoJ) has indicated its readiness to intervene in the market to counter downward pressure on the Yen, as it did on October 3 and December 7, 2023, which significantly altered market sentiment at the time. Similarly, China's central bank is prepared to intervene, as demonstrated on March 25 when the Yuan strengthened notably. The pressure on the Chinese currency is resurfacing, and manipulation of the Yuan's exchange rate may be discussed during U.S. Treasury Secretary Janet Yellen's upcoming visit to China.

In the meantime, the upcoming release of Nonfarm Payrolls data from ADP and the service sector PMI on Wednesday is anticipated to have a moderately negative effect on the Greenback. Similarly, the U.S. labor market report for March, scheduled for release on Friday, is expected to negatively impact the Dollar. With potential actions from the Bank of Japan and China's central bank, the EURUSD may see a return to 1.08500.