The US dollar index (DXY index) has encountered significant selling pressure, signaling a disconnect between the market and the US Federal Reserve’s recent hawkish stance.
In a surprising move, the Federal Reserve projected two additional rate hikes in 2023, despite keeping interest rates unchanged during its latest meeting. This decision was due to concerns over the sluggish decline in inflation. The Fed’s hawkish guidance may be attributed to the economy’s resilience in the face of tighter financial conditions.
The Fed’s dot plot suggests two more rate hikes by the end of the year. The market is currently pricing in a probability of less than 100% for even a single rate hike in 2023. However, with expectations of rate cuts starting as early as next year. In contrast, Fed Chair Powell stated that he does not anticipate a rate cut until inflation shows significant and sustained improvement, which could take a couple of years.
The recent week witnessed significant weakness in the US dollar across markets. After spending a couple of weeks preparing for a breakout at a trendline, the currency experienced a pullback that gained momentum after the FOMC meeting. As a result, prices dipped to test the 103 level, with bears intensifying their selling pressure following the ECB rate decision.
Technical Analysis of the US Dollar
On Friday, the DXY index dropped to 102, a crucial level for the US dollar. This level represents the 50% Fibonacci retracement mark from 2021 to 2022 and also served as previous resistance just before the dollar’s breakout last month.
Although the bullish breakout has faltered, the support at 101 remains significant, having already provided support on two occasions in 2023.
Looking ahead to next week, the market focus will shift back to Fed communications. Thus, including Jerome Powell’s appearance on Capitol Hill for the Fed’s Humphrey Hawkins testimony, held twice a year. This testimony occurs over two days, with the first day usually triggering larger market reactions. Powell will release a prepared statement beforehand, providing an opportunity for him to address the market’s response to recent events. Following that, he will face questions from Congress, specifically the House Financial Services Committee and the Senate Finance Committee.
From a technical standpoint, the support around the 101 level remains crucial, as it previously acted as a bounce point in February and April. This support level has the potential to form a double bottom pattern if it holds. To confirm this pattern, a breach above the 105.88 level is required. However, the bearish trendline that has constrained highs since the beginning of June remains a point of contention.
Additionally, a descending triangle formation is worth noting, with horizontal support and lower-high resistance visible on the weekly chart. For this pattern to trigger, a break of support would be necessary, which would also invalidate the double bottom formation.
Hence, the 100.87-101.00 area on the DXY index is critical to watch in the coming week.
