US Dollar rallies, Argentina to pay for Chinese imports in Yuan

• US Dollar gathers bullish momentum on Friday as markets assess the latest US data.
• USD is up more than 1% against the Japanese Yen following the Bank of Japan’s policy meeting.
• PCE inflation and Employment Cost Index data from United States could drive USD valuation ahead of the weekend.

The US Dollar (USD) has gathered strength in the second half of the week and the US Dollar Index climbed above 102.00 for the first time in a week on Friday. The risk-averse market atmosphere helps the USD find demand as a safe haven while hawkish Federal Reserve (Fed) bets provide an additional boost to the currency.   

Ahead of the weekend, the US Bureau of Economic Analysis (BEA) will release the Personal Consumption Expenditures (PCE) Price Index, the Fed’s preferred gauge of inflation, for March. Employment Cost Index data for the first quarter will also be watched closely by market participants.  

Daily digest market movers: US Dollar rallies despite disappointing Q1 GDP reading

• The BEA reported on Thursday that the real Gross Domestic Product (GDP) expanded at an annual rate of 1.1% in the first quarter, compared to the market expectation for a 2% growth.
• Despite the weak GDP print, the stronger-than-expected increase in the inflation component of the GDP, which could allow the Fed to delay a policy pivot, helped the USD outperform its rivals. 
• Moreover, the 2.26 percentage point negative contribution of the change in private inventories to the GDP seems to be making the growth reading look worse than it actually is, since inventories tend to fluctuate. 
• Commenting on the GDP report, "the US economy grew 1.1% in the first quarter of 2023, slower than in the previous quarter (2.6%). However, the main drag came from significantly lower inventory accumulation, while private consumption remained strong. We still expect the economy to contract slightly in the second half of the year due to the Fed's hefty rate hikes," Commerzbank analysts said.
• According to the CME Group FedWatch Tool, the probability of the Fed cutting its policy rate by 25 basis points in September currently holds at around 40%, down from 60% last week.
• Argentina announced that they will start paying for Chinese imports in Yuan rather than USD in an attempt to limit the USD outflows. Argentina will reportedly pay $1 billion of Chinese imports in Yuan in April and will be paying around $790 million worth of imports in Yuan monthly thereafter.  
• The Bank of Japan (BoJ) left its policy settings unchanged following the April policy meeting. The BoJ left the 10-year Japanese Government Bond (JGB) yield target unchanged at about 0% while maintaining the policy balance rate at -0.1% without altering YCC band.
• In an unexpected move, the BoJ removed its forward guidance, suggesting that it will be more data-dependent moving forward. In turn, USD/JPY gathered bullish momentum and climbed to its highest level in seven weeks near 136.00.
• Previewing the upcoming PCE inflation report, “the ‘tortoise’ of inflation reports tends to provide little surprises, but it still moves markets, even if it is not the ‘hare.’ There are good reasons to expect the US Dollar to fall and equities to rise in response to the data,” said FXStreet Analyst Yohay Elam.

Technical analysis: US Dollar Index techs point to a bullish tilt

The US Dollar Index (DXY) climbed above the 20-day Simple Moving Average (SMA), which is currently located near 101.80, for the first time in 10 days on Friday. Additionally, the Relative Strength Index (RSI) indicator on the daily chart rose to 50, reflecting the lack of seller interest.

In case the DXY manages to end the week above 101.80, it could stage an extended recovery toward 102.60 (static level) and 103.00 (50-day SMA, 100-day SMA). 

If sellers defend 101.80 and don’t allow the index to hold above that level, additional losses toward 101.00/100.80 (psychological level, static level, multi-month low set on April 14) and 100.00 (psychological level) could be witnessed.

How does Fed’s policy impact US Dollar?

The US Federal Reserve (Fed) has two mandates: maximum employment and price stability. The Fed uses interest rates as the primary tool to reach its goals but has to find the right balance. If the Fed is concerned about inflation, it tightens its policy by raising the interest rate to increase the cost of borrowing and encourage saving. In that scenario, the US Dollar (USD) is likely to gain value due to decreasing money supply. On the other hand, the Fed could decide to loosen its policy via rate cuts if it’s concerned about a rising unemployment rate due to a slowdown in economic activity. Lower interest rates are likely to lead to a growth in investment and allow companies to hire more people. In that case, the USD is expected to lose value.

The Fed also uses quantitative tightening (QT) or quantitative easing (QE) to adjust the size of its balance sheet and steer the economy in the desired direction. QE refers to the Fed buying assets, such as government bonds, in the open market to spur growth and QT is exactly the opposite. QE is widely seen as a USD-negative central bank policy action and vice versa.