US Dollar Overview:
- The U.S. is witnessing signs of inflation stabilization, highlighted by the latest headline CPI figures, which have risen for the second consecutive month. Core CPI remains unchanged at 3.3%, consistent with the previous two months. Today's PPI numbers significantly exceeded expectations, registering at 3.0% YoY and 0.4% MoM, surpassing the anticipated 2.6% YoY and 0.2% MoM.
- In a notable development, the European Central Bank (ECB) announced a rate cut this morning, resulting in EUR/USD dipping below the 1.0500 threshold, marking another test beneath this pivotal psychological level.
- Market participants continue to anticipate a 25 basis point rate reduction from the Federal Reserve in the upcoming meeting, with expectations that the Fed will not disappoint. However, the statements and guidance issued during this session could hold more significance than the rate cut itself. Following its last update in September, the Fed projected Fed Funds rates could fall between 3.1% and 3.6% by the conclusion of 2025, and modifications are likely in next Wednesday’s release.
The US Dollar is maintaining its momentum from the post-NFP rally, achieving a new high for December earlier today. Several factors have contributed to this surge, including yesterday's CPI report and this morning's PPI figures. Additionally, actions from other central banks have played a role, as evidenced by the Bank of Canada's 50 basis point rate cut yesterday and the European Central Bank's subsequent 25 basis point reduction. This underscores the divergence in economic data, with the U.S. economy appearing to hold firm relative to many counterparts in Europe and Canada, the latter of which are perceived as more vulnerable to potential trade tariffs.
This strong performance for the greenback in Q4 marks a significant recovery from the oversold conditions seen in Q3, with an aggressive turnaround as the quarter commenced. The strength of the US Dollar received a notable boost around the time of the US elections, leading to a significant decline in the Euro, which propelled the DXY index to challenge the 108.00 mark a few weeks ago.
A pullback occurred post-testing those two-year highs, beginning last Friday alongside the release of NFPs, when a major support level—previously identified from resistance—came back into focus. The 105.44 level, which established support following the election-driven spike in DXY, set the low before bullish activity regained traction.
US Dollar Four-Hour Price Chart
US Dollar Mean Reversion Insight
During a robust bullish trend in the US Dollar throughout 2022, global equities faced considerable challenges. However, as the Dollar began to stabilize and range, global stock markets saw significant rallies that have persisted in the following years.
The recent response of the US Dollar post-election in 2024 mirrors patterns observed in 2016, where a rally in both stocks and the Dollar occurred post-election. However, in 2017, this strength reversed as the Dollar entered a bearish phase, which subsequently fueled a continued rally in both US and global equities.
Based on the daily chart below, it appears the Dollar is approaching a significant resistance zone. The 106.50-106.88 gap from last November’s FOMC meeting has acted as a barrier at various points this year, with the sole breakout attempt proving to be short-lived preceding the recent pullback around the 108.00 mark.
US Dollar Daily Chart
The Broader US Dollar Outlook: Factors Influencing Mean Reversion
While U.S. economic data remains robust, questions linger regarding inflation's trajectory, which have been present throughout the year, reflecting stalled growth or entrenchment at elevated levels. This uncertainty contributed to bullish movements in DXY during Q1 and late-Q2 as speculation grew over the Federal Reserve's potential rate cuts.
After maintaining a consistent stance, the Fed's data eventually opened pathways for a rate move in September. However, by that point, the Dollar had already begun to establish the low for 2024, leading to several false breakouts thereafter, paving the way for a falling wedge and diverging RSI pattern that set the stage for a reversal.
It seems that the market widely anticipates a less dovish stance from the Fed in the next set of projections, but the critical factor will be the extent of any changes. In September, the Fed had projected Fed Funds to be between 3.1% and 3.6% by the end of the following year and 2.6%-3.6% by the end of 2026.
Should another rate cut occur, it could put the FOMC in the 4.25-4.5% range, with current expectations for the end of next year hovering around a 73.3% probability at 3.75-4.00%, and a 41.3% probability at 3.5-3.75%. Therefore, if the Fed’s projections next week suggest an end of 2025 Fed Funds rate between 3.5% and 4.0%, this could prompt ongoing USD mean reversion and sustain the broader range, potentially bolstering equities as we approach next year.
Fed Projections to December 2025
US Dollar Monthly Patterns
Reflecting on the 2016 election's impact, a comparable surge in strength occurred in US markets following a GOP supermajority and Donald Trump's victory. The chart reflects this spike in the blue box spanning November and December 2016. An even more pronounced upward trend in 2017 led to fresh decade highs for the Dollar, with subsequent Dollar weakening aiding a substantial equity rally. During this period, the Fed adopted a hawkish stance, implementing multiple rate hikes despite previous hesitance to move since the Financial Crisis.
The challenging environment during 2022 demonstrates lessons the Fed may wish to avoid, characterized by aggressive rate hikes in response to inflation previously deemed transitory. This strategy resulted in significant stock sell-offs, bottoming out concurrently with the Dollar displaying potential topping signs.
Currently, the green box delineates the USD range of the past two years, which has permitted a robust equity rally to form, a continuation of which the Fed likely favors.
It's crucial to recognize that the US Dollar constitutes a composite of various underlying currencies. Understanding valuation dynamics for a currency involves examining its relation to others, emphasizing that a disparity in economic policy—such as the outlier position of the Fed in 2022—can trigger substantial market ramifications.
US Dollar Monthly Chart
--- drafted by an Analyst
