When will the surging US dollar peak?

The US Dollar Index recently rose from 104 to 106.5, an increase of 2.5%. Market sentiment remains biased towards a bullish outlook on the dollar, with foreign banks generally bearish on the euro. The strength of the dollar is influenced by the Republican victory and international political turmoil. The October US CPI met expectations, with a core CPI month-on-month increase of 0.3%. Federal Reserve officials stated that the risk of rising inflation is not significant, and the economy may face stagnation. Despite rising expectations for interest rate cuts, the dollar index still reached a new high, and attention should be paid to the resistance level at 106.5

The US Dollar Index has risen from 104 before the election to 106.5, achieving a 2.5% increase within a week. Why is the dollar so strong? On one hand, concerns about inflation brought about by the Republican sweep in both houses have led the market to significantly reduce expectations for interest rate cuts by the Federal Reserve; on the other hand, the recent political turmoil in Germany and Japan has also contributed to the strengthening of the dollar.

The US Dollar Index is highly correlated with expectations for US interest rate cuts.

The US CPI for October released last night was completely in line with expectations, with the overall CPI remaining at 0.2% month-on-month for the fourth consecutive month, and accelerating to 2.6% year-on-year. However, the actual month-on-month figure before rounding was 0.24%, while the previous two were 0.18%, indicating the difficulty of achieving the last mile of de-inflation.

Core CPI was 0.3% month-on-month, maintaining at 3.3% year-on-year. From the details, this increase was mainly due to the impact of hurricanes, which caused used car prices to accelerate to 2.7% month-on-month (the hurricanes led to increased demand for vehicle replacements), which may be a one-time factor; aside from this, core commodity prices are all retreating.

Federal Reserve official Kashkari's remarks after the data release were dovish: there is currently no obvious risk of inflation rising, and the greater risk is that the economy may fall into stagnation. This may also be an attempt to rein in the overly optimistic market expectations. Therefore, this CPI report was not unexpected, and a 25bp rate cut in December is also unlikely to be a surprise.

After the data release, there was a divergence in the trends of US dollar interest rates and exchange rates. The US Treasury yield curve steepened, with the short end 2-year Treasury yield falling 6bp to 4.29%, while the long end 10Y Treasury yield rose 3bp to 4.46%. The probability of a 25bp rate cut by the Federal Reserve in December rose from 60% to 80%, but the dollar index rebounded to a new high after a brief decline, with EURUSD falling below 1.06 and USDJPY returning above 155.

Is the dollar's rise overdone? In the short term, market sentiment is still leaning towards a bullish dollar direction. Currently, major foreign banks have a consensus expectation to turn bearish on the euro and the renminbi, but this positioning may already be quite crowded. Attention should be paid to whether the resistance level of 106.5 can be broken (the year-to-date high in April 2024).

The dollar index has risen to a year-to-date high.

Finally, here are two more charts:

Comparing the dollar's performance after the 2016 election, it is surprisingly similar to now; perhaps an inflection point is near?
The US dollar has a seasonal tendency to weaken at the end of the year, and the US Dollar Index has declined in December for the past 7 years.

Author of this article: Fang Yuqi, Source: Good Morning Forex, Original title: "The Soaring Dollar, When Will It Peak?"