US Dollar recovers as markets expect Fed rate hike in May

• US Dollar gathers strength to start the week following Friday’s decisive rebound.
• Markets expect the Federal Reserve to raise its policy rate again in May.
• EUR/USD needs to hold above 1.0900 to keep buyers interested.

The US Dollar (USD) started the new week on a bullish note after having registered strong gains against its major rivals ahead of the weekend. The latest macroeconomic data releases from the United States (US) and hawkish comments from Federal Reserve (Fed) officials help the USD keep its footing.

The US Dollar Index, which tracks the USD performance against a basket of six major currencies, extends its recovery toward 102.00 following a more-than-0.5% increase seen on Friday.  

Daily digest market movers: US Dollar rises on hawkish Fed bets

• The data published by the US Census Bureau revealed on Friday that Retail Sales declined by 1% on a monthly basis in March. On a positive note, March’s reading of -0.4% got revised higher to -0.2%.
• The University of Michigan’s (UoM) Consumer Confidence Index improved modestly to 63.5 in April’s flash estimate from 62 in March.
• The one-year consumer inflation expectation component of the UoM’s survey climbed to 4.6% from 3.6% in March, providing a boost to the USD.
• "Monetary policy will need to remain tight for a substantial period and longer than markets anticipate,” Federal Reserve Governor Christopher Waller said on Friday. Waller further argued that the recent data show that the Fed hasn't made much progress on its inflation goal.
• In an interview with Reuters, Atlanta Fed President Raphael Bostic noted that recent developments in the US economy were consistent with one more rate hike.
• According to the CME Group’s FedWatch Tool, markets are currently pricing in a more-than-80% probability of a 25 basis points (bps) Fed rate hike in May.
• On Wednesday, the Fed will release the Beige Book. Existing Home Sales and Initial Jobless Claims data will be featured in the US economic docket on Thursday ahead of S&P Global’s Manufacturing and Services PMI surveys on Friday.
• Previewing the Fed’s publication, “since the March 21-22 meeting, the data suggest that activity is slowing, the labor market is softening, and price pressures are easing,” said analysts at BBH. “Notably, supply chains continue to improve.  We believe the Beige Book will highlight these trends that support a pause after what is widely expected to be another 25 bp hike whilst leaving the door open for further tightening if needed.”

Technical analysis: US Dollar could stay resilient against Euro

On the daily chart the Relative Strength Index (RSI) indicator declined toward 60 early Monday, suggesting that the pair is staging a technical correction. On the downside, 1.0900 (20-day Simple Moving Average (SMA) aligns as first technical support ahead of 1.0760 (50-day SMA) and 1.0700 (100-day SMA).

In case EUR/USD manages to stabilize above 1.1000 (psychological level, static level), sellers could be discouraged. In that scenario, 1.1100 (psychological level, static level) could be seen as the bullish target before 1.1160 (static level from April 2022) and 1.1200 (psychological level).

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.