What does the current pull-back in USD mean for traders?

Author: Forex Live | Category: Education

What to make of the dollar going forward

TM
USD Softens in Q3

The recent decline in USD on the back of the August jobs report is a great reminder of how fluid the risks are in USD currently. The prior month, a strong beat on the July jobs number sent USD soaring as Fed tapering expectations lifted at the beginning of August. However, a muted reaction from the Fed took the wind out of USD. This was followed by Fed Powell's broadly dovish comments at the Jackson Hole Symposium. The market had been expected the Fed chairman to give a firm signal on tapering, highlighting a timeline for policy normalisation. However, bulls were left disappointed once again as Powell refrained from giving any such signal, instead focusing on the remaining uncertainty and downside risks in the central bank's forecast. This month, then, USD headed lower still as the August NFP came in wildly below forecasts at around 230k, versus 750k estimates.

Despite the weakness in the exchange rate recently, however, the market is still hopeful that the Fed will announce tapering this year. Indeed, despite some recent data softness, a plethora of Fed members have still made the case in favour of tapering this year, worried that leaving it any longer will risk a damaging inflationary overshoot.

Buying Opportunity

With this in mind, the current pull-back in USD can be viewed more as a longer-term buying opportunity than the beginnings of a reversal lower. The Fed has reiterated its support for tapering as soon as possible. Indeed, despite Powell's lack of a clear signal at Jackson Hole, he still opined that tapering was "likely" this year, a sentiment echoed by many Fed members.  Just this week we heard from Fed's Bostic who said that the "possibility of tapering bond purchases this year remains open" adding that, when tapering does occur it is advisable to do it "as quickly as possible".

USD Upside Data Risks

In light of the underlying message here, that the Fed is in favour of tapering and is waiting for the opportune time to do so, USD risks seem skewed to the upside. With this in mind, we can expect plenty of upside USD volatility in response to any key data-beats. Core readings such as inflation, GDP, labour indicators and so forth will provide the best platform for upside USD action across the coming months. Indeed, if data rises significantly in the coming month or two, expect November Fed tapering expectations to amplify significantly.

On the other hand, while any further data weakness is likely to weigh on USD in the short term, it would likely take a material deterioration in economic conditions to affect meaningful USD weakness. As a result, any dips in USD from here on out are likely to simply provide better buying opportunities for longer-term USD players as we pull into Q4 and the issue of tapering takes on sharper focus.

Pandemic Risks Remain

Of course, it must be said that the path of pandemic remains a vital input here and as such, requires monitoring. For now, though Delta cases are rising in the US, with vaccination rates high and increasing, the prospect of fresh lockdowns remains fairly slim and, as such, the economy shouldn't suffer as much as it has during previous waves. Obviously, any change to this will require a reassessment of this view. In the near term, however, the focus remains on US data and Fed speak as the market grapples to establish a position and viewpoint on the likelihood of the Fed tapering in November or December at the latest.

Technical Views

DXY

TM
The three peaks preceding the recent decline in DXY saw plenty of bearish divergence on momentum indicators, flagging such as correction. However, the decline has found support into a test of the 92.07 level, with price since popping back above the 92.51 level. While this support region holds, and with indicators turning higher, the focus is on a continued push higher for USD. The key upside challenges will be a retest of the broken bull channel, along with resistance at the 93.40 and 93.91 level. To the downside, should we break below the current lows, 90.98 will be the next support zone to watch.

This article was submitted by Tickmill.

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