Fed Pushed the Dollar Up

The U.S. Dollar index (DXY) is moving flat this week, up by 0.1% to 104.52, while the EURUSD declined by 0.06% to 1.08670. Overall, the Dollar is trading in a narrow range following the U.S. April inflation report last week. The Consumer Price Index (CPI) showed a slowdown to 3.4% YoY in April from 3.5%, as expected, and the monthly reading came out better than expected at 0.3%. Additionally, Core CPI, which excludes volatile food and energy prices, dropped to 3.6% YoY from 3.8% in March. This marked the first decline in inflation in 2024, bolstering investor confidence. Consequently, bets on interest rate cuts by the Federal Reserve (Fed) in September immediately rose to 53.1% from 49.4%. U.S. 10-year Treasuries yields dropped to 4.31%, the lowest since April 5.

However, a single monthly drop in inflation was not enough to convince Fed officials, who delivered quite hawkish comments last week. The EURUSD retreated from its peak at 1.08950 following these comments. Cleveland Fed President Loretta Mester, Richmond Fed President Tom Barkin, and New York Fed President John Williams voiced support for maintaining high interest rates. As a result, bets on interest rate cuts by the Fed dropped below 50.0% last Friday, and 10-year debt yields climbed to 4.44%. The EURUSD corrected to 1.08350.

This week, Fed officials continued to issue hawkish comments. Fed Vice Chairmen Philip Jefferson and Michael Barr described U.S. inflation data through the first months of 2024 as "disappointing." Investors now believe that the Fed needs to see two more months of declining inflation before considering interest rate cuts. Therefore, inflation needs to slow down in May and June for the Fed to alter its hawkish stance in September. This provides an opportunity for the Greenback to recover its losses with substantial support from the Fed.

The WisdomTree Bloomberg US Dollar Bullish Fund (USDU) reported $2.6 million in net capital inflows last week, following record inflows of $79.7 million during the previous week. This marked the fifth week of positive net inflows out of the last seven weeks, indicating investor confidence in the Greenback strengthening further. The EURUSD may spike to 1.09000 before correcting to 1.05000, or it could drop from its current levels towards this target. Both scenarios have equal chances of materializing. The FOMC Minutes, to be released on Wednesday, could signal the start of either scenario. The second milestone will be on Thursday when May PMI data will be released for the Eurozone, the U.K., and the U.S. Analysts expect PMIs to decline.