By :David Scutt, Market Analyst
- US dollar remains on the backfoot despite improved economic sentiment
- Those looking for a major dovish shift from the Fed at Jackson Hole may be disappointed
- EUR/USD stages bullish breakout as downside economic surprises hit one-year lows
- Higher US yields likely required to fuel further USD/JPY upside
The overview
With little fresh information on the calendar to shift economic sentiment, it’s debatable how much near-term downside is left for the US dollar index (DXY) outside an unlikely extremely dovish tone from Fed speakers at the Jackson Hole symposium. That puts greater emphasis on the price action to dictate direction, meaning technicals and performance of the largest components in the DXY – EUR and JPY – will be important for traders to monitor this week.
Assessing event risk
As covered on Friday, there’s little on the data docket this week to bother traders, especially setups involving the US dollar. Realistically, the only events that may generate volatility are flash PMIs from around the developed world on Thursday and the Jackson Hole economic symposium which culminates on Friday with a speech from Fed chair Jerome Powell.
EUR likely to show interest in PMIs
Given markets tend to put more weight on the ISM PMIs to gauge how the US economy is faring, you get the sense EUR/USD will be the FX pair most interested in the Flash PMIs, providing an indication on how the world’s largest economic bloc is performing as we move towards year-end.
On that subject, it’s interesting to see eurozone economic data surprises – as measured by Citi’s economic surprise index – turned the most negative in a year in the same week EUR/USD broke to fresh year-to-date highs. Given it measures how aggregate economic data performs relative to expectation, it raises questions as to whether the bullish breakout can be sustained without further weakening in the US economy.
Source: Refinitiv
Jackson Hole: low probability high-risk event
As for Jackson Hole, those who have been involved in markets for more than a fleeting moment would know it’s been used by the Fed in the past to deliver major policy announcements, especially during and coming out of the GFC. But we haven’t seen anything like that for years now.
While the Fed and Jerome Powell could shake things up, with markets flirting with the idea that it will deliver 75 or 100 basis points worth of cuts this year, is it likely the Fed will look to shift this pricing even more dovish given the data flow we’ve seen recently? I’m sceptical. Outside the soft July nonfarm payrolls report, the data hardly screams the need to deliver rapid and aggressive rate cuts over the coming months. We just saw the largest one-month increase in retail sales since the start of 2023!
With several inflation reports and another payrolls print to consider, I expect the Fed will continue with the message we’ve heard for months: rate cuts are likely should incoming data build confidence that inflation will sustainably return to target. Yes, there’s more emphasis on labour market data now, but just look at jobless claims over the past two weeks – we’ve seen two big consecutive falls.
For me, it points to the likelihood of disappointment for those hoping the Fed will go full-bore dove with its rates messaging, creating the risk we may see a reversal of some of the US dollar weakness seen since late June, especially given where the DXY sits on the charts.
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https://www.cityindex.com/en-au/market-outlooks-2024/h2-usd-jpy-outlook/
DXY downside appears limited near-term
While the DXY has been a sell-on-rallies play since June, there are signs it may be nearing or have already bottomed in the near-term.
102.37 has brought out the dip buyers on the past three occasions it fell through the level, including last week. With uptrend support dating back to the July 2023 lows and horizontal support at 102 located just below, this zone may prove to be difficult to break without a major fundamental catalyst.
While MACD continues to provide a bearish signal on price momentum on the daily, RSI (14) looks like it may have bottomed, trending gradually higher mirroring the recent price action.
The bottom pane also reveals the DXY’s movements remains largely a function of the US interest rate outlook with the rolling daily correlation with two-year US Treasury yields sitting at 0.88. So, if we don’t see a major dovish shift in Fed rate cut expectations, DXY downside may be hard to achieve this week.
On the topside, DXY struggled at 103 last week. Above, the index topped out earlier this month at 103.53, just below minor resistance at 105.65. Also keep an eye on the downtrend dating back to the highs set in early July.
EUR/USD looking to consolidate bullish break
Contributing to the DXY’s downdraft over the past two months, EUR/USD has surged to levels not seem since the start of the year, staging a successful bullish breakout from downtrend resistance last week after a failed attempt a week earlier.
The bullish engulfing candle from Friday warns of upside, as does MACD and RSI (14) which continue to generate bullish signals on momentum. With the 50-day moving average about to crossover the 200-day moving average from below, the golden cross may embolden bulls to look for a break above 1.10452, bringing a potential test of 1.1140 on the radar.
The technical picture looks great, but I just question whether that alone will be sufficient to deliver upside beyond that already achieved. If we were to see a reversal, 1.0950 would be the first port of call, coinciding with the juncture of horizontal support and former downtrend. If that level were to give way, 108.716, the 50 and 200-day moving averages and 1.0800 are levels to watch.
USD/JPY reverses lower from key level
Explaining the DXY weakness on Friday, USD/JPY reversed lower after failing to break and hold the uptrend it had been sitting in dating back to the start of 2023. To get excited about renewed upside, USD/JPY really needs to break and hold above 149.40, where the price topped out at on Thursday last week. Otherwise, those hoping for a retest of 149.70, 150.90 and 151.95 are likely to be disappointed.
With a rolling daily correlation of 0.96 with US two-year Treasury yields over the past month, yields may need to recover further to encourage the reestablishment of carry trades. On the downside, 146.50 and 143.70 and 141.70 are levels of note.
– Written by David Scutt
Follow David on Twitter @scutty
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