Here’s why the DXY index rally has taken a breather

The US dollar index (DXY) pulled back on Monday as analysts scaled down their Federal Reserve expectations. The greenback is trading at $107.47, which is 1.72% below the highest point this month. This price is also the lowest it has been since July 11th.

Fed expectations

Analysts and investors expect that the Federal Reserve will continue its hawkish tone as inflation surges in the United States. Data published last week showed that the country’s consumer inflation surged to a 40-year high of 9.1% in June this year. This increase was bigger than the median estimate of 8.8%. 

The data came a few days after the US published the relatively strong jobs numbers. The data showed that the economy added over 372k jobs in June even as inflation remained at elevated levels. The unemployment rate remained unchanged at 3.7%.

Meanwhile, consumers continued spending in June, according to the latest retail sales data. Therefore, the DXY index rose as investors priced in a more hawkish tone. They started to believe that the Fed will hike interest rates by a whopping 100 basis points. This view was supported by Christopher Whaller, who is a member of the FOMC committee.

Now, the weak quarterly results by many American firms has seen analysts lower their expectations about the Fed. According to the Walll Street Journal, some of the FOMC committe it talked with said they were afraid of overdoing rate increases. As such, they believe that the bank will hike by about 0.75% in its meeting later this month. Esther George said:

“A rapid pace of rate increase brings about the risk of tightening policy more quickly than the economy and markets can adjust.”

The next key catalyst for the DXY index will be the upcoming interest rate decision by the European Central Bank (ECB) and UK GDP numbers.

US dollar index forecast

The dollar index has been in a strong bullish trend in the past few months. This saw it jump to a multi-decade high of $109.30. It has now pulled back and is trading at $107.53. The index has moved below the 25-day and 50-day moving averages while the MACD has moved close to the neutral point.

Therefore, the US dollar index will likely continue falling as sellers target the next key support point at $105.82. In the long-term, however, the bullish trend will likely resume. This is in line with my previous DXY index forecast.

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