US Dollar loses momentum as risk flows return on debt ceiling deal

• US Dollar struggles to build on last week's gains.
• US Dollar Index stays on the back foot as risk mood improves on debt-limit deal.
• Investors await May Consumer Confidence Index data from the US.

The US Dollar (USD) finds it difficult to preserve its bullish momentum on Tuesday as investors move toward risk-sensitive assets on hopes of the US debt-ceiling bill being finalized in the next couple of days. The US Dollar Index, which touched a fresh multi-month high above 104.50 earlier in the day, was last seen retreating toward 104.00. In the meantime, US stock index futures gain between 0.3% and 1.1%, reflecting the improving market mood.

The USD's valuation is likely to continue to be impacted by risk perception ahead of the highly-anticipated labor market data that will be published later in the week.

In the second half of the day, the Conference Board (CB) will release the Consumer Confidence Index data for May. More importantly, the House Rules Committee is scheduled to vote on the 99-page bill that US President Joe Biden and House Speaker Kevin McCarthy agreed on to suspend the debt-ceiling before sending it to the House floor for a final vote on Wednesday.

Daily digest market movers: US Dollar struggles to find demand

• Previewing the upcoming confidence data, "the CB Consumer Confidence Index fell in April to 101.3 from 104.0 in March and is expected to have shrunk further in May to 99.1," noted FXStreet Analyst Valeria Bednarik. "Since February 2022, the Expectations sub-component has remained below 80, a level usually associated with expectations of a recession within the next year.  In fact, the sub-index fell to 68.1 in April from 74 in the previous month, indicating people do not see the situation improving and still fear worsening economic conditions."
• Following the three-day weekend, US Treasury bond yields opened lower on Tuesday. The benchmark 10-year yield was last seen losing more than 1% on the day near 3.7%. Nevertheless, the CME Group FedWatch Tool still shows that markets are pricing a less than 40% probability of the US Federal Reserve (Fed) leaving its policy rate unchanged in June.
• On Sunday, US President Joe Biden and Republican House Speaker Kevin McCarthy reached an agreement to temporarily suspend the debt-limit to avoid a US debt default. The House of Representatives and Senate still need to approve the deal, which will suspend the $31.4 trillion debt-ceiling until January 1, 2025, in coming days. 
• The US Bureau of Economic Analysis (BEA) reported on Friday that inflation in the US, as measured by the change in Personal Consumption Expenditures (PCE) Price Index, rose to 4.4% on a yearly basis in April from 4.2% in March.
• The annual Core PCE Price Index, the Fed's preferred gauge of inflation, edged higher to 4.6%, compared to the market expectation of 4.6%. 
• Further details of the BEA's publication showed that Personal Income increased 0.4% on a monthly basis while Personal Spending rose 0.8%.
• Cleveland Fed President Loretta Mester told CNBC on Friday that PCE Price Index data underscore the slow progress on inflation. "It's important for the Fed not to under tighten the monetary policy," Mester added.
• On Thursday, the ADP will release the private sector employment data ahead of the US Bureau of Labor Statistics' Nonfarm Payrolls (NFP) data for May on Friday.

Technical analysis: US Dollar Index stays bullish despite the latest pullback

The Relative Strength Index (RSI) indicator on the daily chart retreated toward 60 early Tuesday after touching 70 on Monday, suggesting that the US Dollar Index (DXY) is staging a technical correction rather than turning bearish. 104.00 (Fibonacci 23.6% retracement of the November-February downtrend), however, aligns as key support. A daily close below that level could attract USD sellers and open the door for an extended slide toward 103.00, where the 100-day Simple Moving Average (SMA) is located.

If DXY continues to use 104.00 as support, buyers are likely to remain interested. Additionally, the bullish cross seen in the 20-day and the 50-day SMAs confirms the bullish bias. On the upside, 104.50 (daily high) aligns as interim hurdle ahead of 105.00 (psychological level, static level) and 105.60 (200-day SMA, Fibonacci 38.2% retracement).

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.