The Dollar is Preparing for Correction after Dovish Fed and Weak Labour Market

The U.S. Dollar index has seen a modest 0.2% rise to 105.30 this week, while the EURUSD has experienced a slight 0.1% decline to 1.07550. Other major reserve currencies have followed a similar trajectory, with the exception of the Japanese Yen, which has lost 1.1% to 154.60.

Several factors have contributed to the recent fluctuations in the Dollar. Firstly, the Bank of Japan (BoJ) intervened in the currency market twice, significantly impacting the USDJPY exchange rate. The first intervention occurred on April 29, when the USDJPY reached 160.16, prompting the BoJ to inject around $36.5 billion to support the Yen. A second intervention followed on May 1, with the BoJ injecting $22.5 billion, bringing the USDJPY down to 153.00.

The Dollar also reacted to the unexpectedly dovish statement from the Federal Reserve (Fed) after its May 1 meeting. Despite rising inflation in February and March, the Fed announced a reduction in its quantitative tightening program to $25 billion per month from $60 billion starting June 1. Fed Chair Jerome Powell explicitly stated that there would be no further interest rate hikes.

The USD faced further pressure following the release of the U.S. labour market report for April, which fell significantly short of expectations. Nonfarm Payrolls came in at 175,000 compared to the anticipated 238,000, while the unemployment rate edged up to 3.9% and average hourly earnings slowed to 0.2% MoM.

Despite these downward factors, the WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU) reported net capital inflows of $1.3 million last week, indicating sustained interest in the Dollar. Investors appear hesitant towards the declining Dollar amidst a rising S&P 500 index, likely increasing positions in other safe haven assets in anticipation of potential turbulence in May and June.

Meanwhile, Richmond Fed President Tom Barkin and New York Fed President John Williams already contributed to the dovish message of the Fed. Neel Kashkari form the Minneapolis Fed, Fed Governors Lisa Cook and Michele Bowman are likely to sound dovish too this week. Most important sounded the message from Japan's vice minister of finance for international affairs, Masato Kanda, when he indirectly admitted that no further interventions are planned by saying that the authorities would act if excessive moves triggered by speculators negatively impact the daily lives of people.

The outlook for the EURUSD suggests a movement towards 1.09300-1.10300 by the end of May, with a potential retreat to 1.07000-1.07300 before a rebound towards 1.08000-1.08300. Monitoring the capital balance of the USDU could provide insights into the future movement of the Greenback.