US DOLLAR KEY POINTS:
- U.S. dollar jumps despite lower U.S. Treasury yields, with the large drop in the euro explaining this move
- U.S. third-quarter GDP tops expectations, but the internals point to economic weakness
- All eyes will be on the Core PCE report on Friday
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The U.S. dollar, as measured by the DXY index, jumped on Thursday, rising about 0.8% 110.58, boosted by a steep drop in the euro following the European Central Bank’s monetary policy announcement. For context, the ECB raised interest rates by 75 basis points to 1.50%, in line with expectations, but failed to embrace a hawkish stance amid mounting recession risks.
Today’s moves in the FX market came despite a sharp drop in U.S. Treasury yields seen across the curve in the wake of the release of U.S. gross domestic product data. Although third-quarter GDP surprised to the upside, growing at an annualized rate of 2.6% versus the 2.4% expected, the outturn was driven by the external sector, with other components largely muted, a sign of underlying economic weakness.
In the face of rapidly softening demand conditions, the FOMC may be on the verge of adopting a less forceful and more data-dependent tightening bias, slowing the pace of interest rate hikes to avoid a severe downturn that could crush the labor market. This would not yet constitute a pivot, but it would be the first step in that direction.
To better anticipate when the U.S. central bank may begin to change its strategy, it is important to closely watch how inflationary pressures evolve in the country. That said, traders will have a chance to assess the consumer price outlook on Friday when the U.S. Commerce Department releases the September Core PCE figure, the Federal Reserve’s favorite inflation gauge. This metric is forecast to have risen 0.2% month-over-month and 5.2% year-over year.
For the Fed to become less hawkish going forward, there should be convincing evidence that inflation is moderating, so the lower the core PCE number, the better the prospects for this narrative. In the same vein, a weak number should put downward pressure on yields, creating a more favorable backdrop for near-term US dollar weakness.
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US DOLLAR INDEX (DXY) TECHNICAL ANALYSIS
After Thursday’s rally, the DXY index appears to be approaching a key resistance in the 110.75 area, near the 50-day simple moving average. If bulls manage to push prices above this barrier, buying momentum could accelerate, paving the way for a move towards 111.70, followed by 113.50. On the flip side, if sellers return and spark a bearish reversal, initial resistance is located around 109.30/109.00. If this zone is breached, a drop towards 107.70 cannot be ruled out.
US DOLLAR TECHNICAL CHART
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—Written by Diego Colman, Market Strategist for DailyFX