US Dollar Index Hits Two-Month Low Amidst Potential Pause in Interest Rate Hikes

Key Insights

• US dollar index hits a two-month low as Fed officials discuss holding off on future interest rate hikes based on incoming data.
• US Treasury yields decline, with the recent double high potentially marking a cycle peak for the UST 2-year.
• Anticipated drop in US headline inflation to 3.1% from 4.0% last month, while core inflation remains slightly sticky at 5.0%, posing concerns for the Federal Reserve.

The US dollar index has recently reached a fresh two-month low following comments from Federal Reserve officials, indicating a potential pause in future interest rate hikes depending on incoming data.

While a 25 basis point increase has already been fully priced in for this month, it appears that the US central bank is contemplating a halt to further tightening measures, effectively ending the monetary policy tightening observed over the past 15 months.

The latest probabilities from the CME Fed Fund futures align with the Fed’s current sentiment, suggesting that rates will peak this month and then remain relatively stable heading into the next year.

In response to these developments, US Treasury yields experienced a downward shift, with the recent double high ranging from 5.08% to 5.11% now regarded as a potential cycle peak for the UST 2-year, which is highly sensitive to interest rate fluctuations.

What to Expect From the US Inflation Report

Looking ahead, the upcoming US inflation report, set to be released on Wednesday, is anticipated to reveal a significant decline in annual headline inflation from 4.0% to 3.1% compared to the previous month (May).

Read also: US Dollar Set to Extend Gains Against Chinese Yuan in Q3 2023

It is worth noting that headline inflation stood at 9.1% in June of last year. However, core inflation, which excludes volatile components, remains somewhat resilient and is expected to decrease slightly from 5.3% to 5.0%, presenting a continuing concern for the Federal Reserve.

Forecasting the Future Trajectory of the US Dollar Index

Examining the daily chart of the US dollar, we observe a substantial decline since last Friday, with the currency breaching both the 20- and 50-day simple moving averages.

The greenback is now approaching a support zone formed by a cluster of previous lows recorded between early April and mid-May this year.

It is likely that this support zone will provide some resistance against further downside in the short term, before the psychologically significant 100 level becomes a potential target.

Nevertheless, given the expectation that short-term US bond yields will either remain at their current levels or slightly below, the US dollar is poised to face additional pressure from currencies that are undergoing their own ongoing rate hiking cycles, particularly the Euro and the British Pound.

Consequently, external factors are likely to shape the future trajectory of the US dollar index in the coming months.

What impact could the potential pause in interest rate hikes and external factors have on the future trajectory of the US dollar index? Let us know in the comments.