The US dollar has added 1.5% so far this month against a basket of the most popular currencies due to reassessment of the Fed’s monetary policy outlook after healthy macro data. Having gained almost daily since the beginning of last week, the DXY returned to 93, an area of local highs from which it has already reversed downwards twice this year.
From all indications, strong job statistics and increasingly explicit comments from Fed officials about an imminent unwinding form the basis for an extended upward trend in the dollar. However, cautious traders would prefer to see a few confirmations along the way.
Firstly, we shall wait for the index to rise above the 93.5 level, the highs of March. That would confirm an upside exit from the long sideways range and proof of the real strength of the dollar bulls, who had earlier lost power on the way to that area.
Secondly, an important test for the dollar will be today’s release of US consumer inflation for July. Prices are expected to rise by a further 0.5% after a jump of 0.9% in June. The year-over-year rate is forecasted to slow from 5.4% to 5.3%. For the past five months, the data has constantly beaten expectations, surprising economists who, on average, are very good at predicting the rate of price growth. Another “positive” surprise has the potential to be the rock that could set off an avalanche and trigger a mighty dollar uptrend.
If the Fed chooses not to see another acceleration in inflation, it could undermine confidence in the central bank. However, the chances are much higher than the Fed informally looks at inflation as an increasingly long-term potential risk. A strong dollar and tight monetary policy are the available tools to fight long-term inflation.
At the same time, another outcome must not be dismissed: Inflation could come out markedly weaker than expected and start to decelerate sharply. In that case, the debate that the Fed should not rush to curtail stimulus may come back to life. And this could trigger a new downward reversal of the dollar.
