The Fed Put Strong Pressure on the Dollar

The U.S. Dollar has shown unusual stability since the start of the week. The U.S. Dollar Index (DXY) is up slightly by 0.05% to 100.77 points. However, the picture varies significantly when comparing the Greenback against different reserve currencies. The Dollar strengthened by 0.2% against the Euro, while retreating by 0.4% against the British Pound. The Japanese Yen has fallen by 0.5% to the Dollar, while commodity-driven currencies such as the Canadian, Australian, and New Zealand Dollars have risen by 0.5-0.6% against the Greenback.

These movements were triggered by the Federal Reserve's (Fed) recent half-point interest rate cut, which has caused high volatility in the currency markets last Wednesday. Without this cut, the Dollar would likely have strengthened, supported by strong U.S. macroeconomic data, such as robust retail sales, lower initial jobless claims, and mixed PMIs, all pointing towards a stronger Dollar. Investors view the Fed’s large rate cut as unnecessary, especially given the strong economic indicators.

So, why did the Fed make this move? The U.S. central bank and its Chair, Jerome Powell, have faced criticism, with some suggesting political motivations. Alternatively, Powell may have concerns about the U.S. economy that he hasn’t disclosed, though this seems unlikely, as he emphasised the strength of the American economy during his press conference. Former New York Fed President William Dudley later suggested that Powell is more concerned about potential weakening in the labour market than he admits. This authoritative perspective shields Powell from political accusations, though Donald Trump has criticised Powell for not opting for a more modest quarter-point cut.

The situation has caught large investors off guard. The WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU) recorded net outflows of $8.0 million, as investors began closing their positions at a loss. Despite this, there remains around $10.0 million in bets on a rising Dollar over the past six weeks. However, the Dollar’s future direction is uncertain.

Bets on another large half-point Fed interest rate cut in November are hovering around 50%. With this sentiment, the Dollar is unlikely to recover its losses unless other central banks provide support. On Thursday, both Powell and European Central Bank (ECB) President Christine Lagarde are scheduled to speak, which could influence the situation.

A strong Q2 GDP figure of 3.0% QoQ in the U.S. could also help strengthen the Dollar. However, the PCE index for August is expected to slow to 2.3% YoY from 2.5%, potentially pushing the Fed towards another half-point rate cut, weakening the Dollar further.

From a technical perspective, the EURUSD has broken through the 1.10000-1.11000 resistance and is now poised for an upside scenario, with targets at 1.14000-1.15000. However, the situation remains unclear, and it would be prudent to wait for more reliable signals. For confirmation of the next move, the pair needs to consolidate above 1.11800-1.11900.