The Dollar May be Seeking Further Downside

The U.S. Dollar is weakening since the beginning of the week. The U.S. Dollar index (DXY) has dropped by 1.4. The EURUSD even climbed to 1.08870, which is the first downside target for the Greenback within the range of 1.08500-1.09500.

Most of the weekly weakening of the U.S. Dollar was recorded on Tuesday after the release of the U.S. October inflation data. All indicators came in lower than expected. The headline inflation (CPI) fell to 3.2% YoY beating forecasted 3.3% YoY. Monthly inflation fell to 0.0% versus expectations of 0.1%. An unexpected decline in core CPI, excluding food and energy prices, had a particularly strong effect. Instead of stabilising at 4.1% YoY and 0.3% MoM reported in September, core inflation fell to 4.0% YoY and 0.2% MoM respectively. 

This immediately affected markets. U.S 10-year Treasuries yields fell to 4.43%, the lowest level since September 2022. The S&P 500 broad market barometer performed the best daily rise since April at 2.1%. The U.S. Dollar had no choice but to retreat by about 1.7% on Tuesday alone. It has recovered some of the losses since then, as the oversold tension was mostly removed. Meanwhile, investors are considering a steeped decline of the Dollar towards 1.08500-1.09500 against the Euro after a much-unexpected inflation surprise. According to the CME FedWatch Tool, the probability of a December Federal Reserve (Fed) interest rates hike fell to 5.2% from 14.5% before the data was published. Moreover, investors now expect the first interest rate cuts in May 2024 with a 48.5% probability instead of July. Investors are mostly convinced that they have seen the end of the monetary tightening cycle.

On the other hand, capital flows into the WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU) indicates that the American currency may recover. Capital outflows have declined dramatically. However, this does not meant that the capital flows could reverse this week. But it is worth noting the rapid return of investors to buying of the Dollar even after brief sell-offs like it happened on Tuesday. This could indicate either a lack of belief in the end of the Fed's tightening cycle, which doesn’t correspond with the CME FedWatch Tool data. Alternatively, investors see other reasons for the upcoming U.S. Dollar rally. This could be attributed to fears of a recession, geopolitical factors s or another kind of force majeure that would boost the demand for the American currency.

A technical modeling suggest that the EURUSD could decline towards 1.12000-1.13000 by the end of the 2023 if the Dollar fails to reverse sharply by the end of next week. Taken all together, this indicates an increased uncertainty in the currency market. It is too early to make any decisions now. Investors need a pause for at least another week to adjust their positioning.