US dollar shows who's boss, rallies back into bullish territory

• DXY bulls are moving back in and 109.72 guards a break to the 109.90s.
• A break of the 109.40s and 109.10s below there opens the risk of a significant downside extension. 

The US dollar rallied on Tuesday against the yen, euro and other currencies following stronger-than-expected US inflation data that rocked US stocks, bolstered US yields and sent the greenback towards last week's two-decade peak of 110.79. The price made a high of 110.01 before bears cleaned up across the counterparts for low-hanging fruit in the corrections. 

However, while the DXY fell to a low of 109.257, it did not stay down there for long. The index has since rallied back to test the 109.70s which is encouraging for the bulls. Technically, the bulls will want to see 109.90 cleared before the week is out ahead of what is expected to be a hawkish Federal Reserve outcome next week. 

There are no Federal Reserve speakers this week as the media blackout went into effect at midnight Friday ahead of Chair Jerome Powell’s post-decision press conference on September 21. Traders expect 75 basis points when its policy committee meets next week and lower market hopes for a smaller increase. However, there is a one-in-five chance that the Fed will raise rates by a full percentage point, up from zero a day before the inflation report according to FEDWATCH. 

Yesterday, Consumer Price Index gave the greenback a boost as the headline came at 8.3% YoY vs. 8.1% expected and 8.5% in July, while core came in at 6.3% YoY vs. 6.1% expected and 5.9% in July.  ''While this was still the second straight month of deceleration for headline from the 9.1% peak in June to the lowest since April, it’s a huge reminder that the Fed’s fight against inflation is nowhere close to being over,'' analysts at Brown Brothers Harriman explained. 

''We think it would be very tempting for the Fed to hike 100 bp in order to underscore its inflation-fighting credentials and surprise the markets,'' the analysts said. ''Equities would tank but that's what the Fed wants. More importantly, the swaps market is now pricing in a terminal rate between 4.25-4.50%.''

Positioning data shows the market is long dollars but not remarkably so by historical standards. Speculators’ net long USD index positions edged slightly higher but remain within the recent range, a little below the levels reached in the run-up to the Fed’s Jackson Hole event. Interest rates have been a major driver of the greenback, as higher rates give dollar bonds and deposits attractive yields. Outside the United States, especially in Asia, major economies' rates trajectories stand in stark contrast which is expected to continue supporting the greenback which is up nearly 15% against a basket of currencies in a rally that has the dollar on course for its best year since 1984.

DXY technical analysis

The four-hour chart above illustrates the market structure and the bulls that are attempting to show who is boss by taking on the M-formation's neckline. 109.72 guards a break to the 109.90s and prospects of a bullish continuation for the days and weeks ahead. A break of the 109.40s and 109.10s below there opens the risk of a significant downside extension.