US Dollar Fundamental Forecast: Bullish
- US Dollar gains for a sixth week but upside strength is easing
- Removal of Omicron risk aversion may bode well for the USD
- EUR/USD likely to resume as the driving force for DXY index
- US inflation data may boost the Greenback on strong data
The US Dollar finished higher for the sixth consecutive week after November's non-farm payrolls report crossed the wires Friday. However, US Dollar bulls appear to be easing off the gas despite increasingly strong Federal Reserve rate hike bets. Meanwhile, stock market volatility increased last week due to the Omicron variant threat. That likely helped prop up the US Dollar given its safe-haven appeal.
Analyzing movements in the US Dollar DXY index requires an understanding of how the index is compiled. DXY weighs the US Dollar versus a basket of currencies, with the Euro , Japanese Yen , British Pound and Canadian Dollar weighing at 57.6%, 13.6%, 11.9% and 9.1%, respectively. That said, looking at the individual movements in the respective pairs shows that the US Dollar's strength has largely stemmed from British Pound weakness last week, with GBP/USD dropping over half a percent on the week.
The Japanese Yen – another safe-haven currency – gained half a percent last week. EUR/USD was nearly unchanged. That movement is revealing yet unsurprising given the risk-off market response to the Omicron variant. This sets up a potential roadmap for DXY's direction in the coming weeks. If scientists assess that Omicron doesn't pose a more grave threat than the Delta variant, markets may go back into a risk-on stance.
That would likely flip the script for movement in USD/JPY and GBP/USD, but what about the DXY's largest component, EUR/USD? The Euro has shown its own safe-haven appeal recently, with the currency gaining against the British Pound, Australian Dollar and New Zealand Dollar last week. That appears to have eased the Greenback's haven appeal versus the Euro, especially considering the already large drop seen in the EUR/USD pair over the last several months.
However, the removal of market risks would likely leave the other driving force in charge: interest rate differentials. The US Dollar has an advantage in that regard, given that the Federal Reserve is in a relatively more hawkish position on policy versus the European Central Bank (ECB). With that in mind, the US Dollar is likely to continue gaining versus the Euro should Omicron risks fade. (see chart below comparing implied policy rates and the US Dollar).
That brings the focus back to economic data concerning Fed rate hike bets. This week's inflation data via the consumer price index (CPI) will be key for DXY direction. November's core CPI – a measure given more weight by the Fed since it strips out volatile food and energy prices – is expected to cross the wires at 4.9% y/y. That would be up from 4.6% in October, which spurred a move higher in the Dollar. Assuming a similar market reaction, a better-than-expected CPI print should send the US Dollar higher once again.
--- Written by Thomas Westwater, Analyst for DailyFX.com
To contact Thomas, use the comments section below or @FxWestwater on Twitter
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