USD Outlook – Rising Inflation & Hawkish Yellen

Feb 16, 9:12 am
FOMC_Yellen

The US dollar seems to be caught between a dovish President Trump and the hawkish central bank. After trading weaker for the most part of January, the US dollar was seen rising steadily since early February despite some setbacks on allegations of currency manipulation by the US administration on some of its key trading partners.

This week, it was the turn of hawkish Fed. Much to the market surprise, Ms. Yellen’s remarks were more hawkish than expected, especially after considering that the Federal Reserve’s last meeting in early February did not carry much detail on the timing of the next rate hike.

5-yr break even inflation rate (as of week ending Feb 10, 2017)
5-yr break even inflation rate (as of week ending Feb 10, 2017)

The rather uneventful Fed meeting alongside weaker pace of wage growth saw the markets settle into a sense of complacency with the expectations for a rate hike at the March meeting falling. Investors were woken up this week as the Fed Chair told lawmakers during her two-day annual testimony to Congress that the Fed cannot afford to delay rate hikes any longer for fear of falling behind the curve and ending up having to hike rates at a faster pace than it expected, even risking recession.

Ms. Yellen gave a broadly positive report on the U.S. economic outlook noting that the job market was strengthening albeit some slack still remaining. She was also positive on inflation that it would rise to the Fed’s 2% rate. This view was later confirmed by market reports on Wednesday as the January consumer price index data showed that headlined inflation rose 2.5% on an annual basis in January, up from 2.1% previously and beating estimates of 2.4%. Core inflation, which strips the volatile food and energy prices also increased above the 2% threshold, rising 2.3% in January, from 2.2% in December and above estimates of 2.1%.

The Fed Chair said that the FOMC members would continue to assess the economic developments and take a call on whether it would be appropriate to hike interest rates or not. This comment briefly sent the expectations for a March rate hike from 17% to about 26%, tracked the CME Group’s Fed fund futures tool and increased to 41% for May and 45.8% for June.

Investors also wait for Trump’s tax announcement

Meanwhile, besides the Fed keeping the markets on the alert for a possible rate hike, investors are also bracing up for the tax announcement from President Trump. “Lowering the overall tax burden on American business is big league … that’s coming along very well,” the U.S. President said, noting that his team was ahead of schedule and that an announcement would be made over the next two or three weeks time. This was in early February, which puts the timeline of the announcement any time by late February or early March.

The news brought some cheer to the market participants who have been early waiting since January 25th this year for some announcement on the planned fiscal spending and proposed tax reforms.

The U.S Dollar Index – A contrarian view

EURUSD could see upside to 1.0800, 1.1000 while GBPUSD could see gains to 1.2700, based on this view.

While the above factors seem to be positive for the U.S. dollar, the ICE Futures US dollar index paints a different picture, one this signals a near-term decline that could catch the markets off-guard.

The first chart here is the weekly time frame chart for the U.S. dollar index. The chart shows that within the rising Pitchfork, we see the support formed at 99.38 and a potential head and shoulders pattern evolving.

US Dollar Index – Watch the evolving head and shoulders pattern
US Dollar Index – Watch the evolving head and shoulders pattern

The identified reversal level is between 101.95 and 101.30, which was tested yesterday. A bearish follow through from here will see the U.S. dollar index dip back towards the neckline support at 99.38.

A breakdown below this level will trigger declines towards 97.56 followed by the eventual test to 95.00 as the minimum objective.

The next chart below is the daily chart time frame. Here 100.50 support is critical to this analysis as a bearish close below 100.50 is essential to form the downside bias in the U.S. dollar which will increase the confidence in this analysis for a test to the neckline support at 99.38.

US Dollar Index – Daily time frame (Watch support at 100.50)
US Dollar Index – Daily time frame (Watch support at 100.50)

In the event that the U.S. dollar bounces off 100.50, there could be some consolidation near 101 – 102 levels, but further upside can only be confirmed on a breakout above 102.00. This essentially puts EURUSD and GBPUSD to the upside. So far, GBPUSD has bounced off 1.2400 handle as mentioned earlier this week following the lackluster inflation reading and weak wage growth.

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John has over 8 years of experience specializing in the currency markets, tracking the macroeconomic and geopolitical developments shaping the financial markets. John applies a mix of fundamental and technical analysis and has a special interest in inter-market analysis and global politics.

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