The Dollar is Ready to Strike Back

The U.S. Dollar index (DXY) has declined by 0.35% to 104.27 this week, while the EURUSD has risen by 0.3% to 1.08870. This weakness of the Greenback is unusual given the low trading activity during the U.S. Memorial Day holiday on Monday. Typically, global trading activity remains subdued and exchange rates mostly unchanged during U.S. holidays. However, the Greenback continued to weaken on Tuesday morning, raising suspicions that someone might be manipulating the market to knock out long position traders.

Despite this, the fund flows of the WisdomTree Bloomberg US Dollar Bullish Fund (USDU) do not indicate a significant shift in investor sentiment towards a weaker Dollar. The fund recorded its largest net inflows since April 2022, with $73.1 million in early May, followed by net inflows of $2.6 million without any outflows. This suggests that large investors still believe in the potential for a stronger Dollar soon.

The Federal Open Market Committee (FOMC) Minutes released last week support a stronger Dollar. The FOMC members indicated their readiness to maintain high interest rates for an extended period. If inflation remains stubborn in May and June, some members are prepared to vote for another rate hike. This hawkish stance was reinforced by recent U.S. business activity data, where Manufacturing PMI rose to 50.9 points and Services PMI increased to 54.8 points, both surpassing consensus expectations.

U.S. 10-year Treasury yields, which had fallen to 4.31% on lower-than-expected inflation, have rebounded to 4.45-4.50%. Bets on Fed interest rate cuts in September have decreased from 53.0% to 45.0%, according to the CME FedWatch Tool. Investors are now focused on the upcoming Q1 GDP data, expected to decrease to 1.3% from the initial estimate of 1.6%, and the PCE index due on Friday, which is expected to remain mostly unchanged. This could boost the Dollar by 0.7-1.0%.

Additionally, an interest rate cut by the European Central Bank (ECB) that is expected next week could further support the Dollar if the Fed maintains its hawkish stance.