Dollar Is Ready to Jump

The U.S. Dollar Index (DXY) is seeing a modest rise of 0.1% this week, reaching 100.80 points, while the EURUSD pair has declined by 0.15% to 1.11700. The Dollar is showing mixed performance against other reserve currencies, but it has maintained its strength following a significant 1.6% surge on Friday. This uptick came after Federal Reserve Chairman Jerome Powell signaled the onset of an interest rate cut cycle by declaring, "the time has come."

Powell’s remarks marked a notable shift in the Fed's priorities, as he emphasized that inflation, now moving steadily toward the 2.0% target, is no longer the central concern. Instead, the focus has shifted to the labor market, which seems to have become a primary issue for policymakers. This pivot is surprising, given that Powell was previously cautious about reducing interest rates. The abrupt change in stance may be attributed to the substantial downward revision of Nonfarm Payrolls figures, which were adjusted down by 818,000 to 2.082 million for the period between April 2023 and March 2024—the most significant revision since the 2009 financial crisis.

The drop in Manufacturing PMI to 48.0 points in August, the lowest level of the year, combined with rising unemployment, may be painting a recessionary picture for the Fed. Powell’s dovish tone at the Jackson Hole symposium last Friday could be an indication that the Fed is concerned about being too late to address the economic slowdown, particularly as the labor market appears to have shifted into contraction.

The American debt market has responded with relative calm, as the benchmark 10-year Treasury yields initially dropped to 3.79% from 3.93% following Powell's speech, before edging back up to 3.84% later in the week. Despite the modest gains in the Dollar, there is potential for further upside. This view is supported by significant inflows into the WisdomTree Bloomberg US Dollar Bullish Fund (USDU), which recorded $39.9 million in net inflows last week, all occurring after Powell’s address. This marks the largest inflow since early May, a period during which the Dollar appreciated 2.0% against the Euro in one month.

Given the current market sentiment, overbought conditions for the EURUSD pair are intensifying. Large investors are anticipating a further decline of 1.0-2.0%, potentially pushing the pair down to 1.10000-1.11000. Should the pair drop below 1.10000, a more pronounced downward reversal in the currency market could unfold.

Looking ahead, there are no major events expected to shake the currency market this week. The second estimate of Q2 U.S. GDP is anticipated to be neutral, at 2.8% QoQ, while Initial Jobless Claims are expected to rise. The July PCE index is forecasted to deliver mixed results. However, given Powell’s recent comments downplaying inflation concerns, these data points may have little impact on the market.