The Dollar Recovery May Not Be Long

The U.S. Dollar is gaining strength this week, with the U.S. Dollar Index (DXY) rising by 0.7% to 103.08, marking the highest level so far this year. The EURUSD has lost 0.6%, trading at 1.08800, representing the most significant gains for the Dollar since January 5.

The strengthening of the Greenback is supported by positive macroeconomic data in the United States. The latest labor market report for December 2023 showed strong indicators, and inflation is on the rise. The U.S. 10-year Treasuries yields increased to 4.00-4.10% from 3.80% on this news, contributing to the Dollar's 1.5% gain. However, the potential for a further rally is limited as investors are focused on achieving a new stock market record above 4819 points for the S&P 500 broad market index. Higher borrowing costs could significantly impact the ability to set this record.

The Greenback responded to rising yields, and attempts by European officials to support the Euro had limited success. Bundesbank President Joachim Nagel and Austria’s Central Bank Governor Robert Holzman, both European Central Bank (ECB) Governing Council members, stated that it is too early to discuss interest rate cuts. Despite these efforts, the Euro disregarded this verbal support, while the Dollar gained ground on Tuesday, increasing by 0.6% against the single currency. Bets on interest rate cuts by the Federal Reserve (Fed) in March dropped to 66.3% from 76.9%, according to the CME FedWatch Tool. Investors are finding it challenging to ignore the potential inflation threat in the U.S.

The WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU) experienced capital inflows last week, highlighting a contradiction between investors' desire to set a new stock market record and secure their funds against rising inflation in Treasuries.

From a technical perspective, the EURUSD may experience another 0.3-0.4% downside to 1.08600-1.08800, but it is likely to be limited by this strong support level. The U.S. retail sales data and inflation report in the Eurozone on Wednesday are unlikely to provide further strength to the Dollar. ECB President Christine Lagarde, who will be speaking at the World Economic Forum this week, may not provide enough upside momentum for the Dollar. Stronger catalysts are needed for the Greenback to break through the support at 1.08600-1.08800.