US Dollar Index Approaches Resistance Zone Ahead of Key Data: How to Trade It

After a stronger start to the year, the US dollar is coming under a bit of pressure, as pound and euro all attempt to make a recovery after their poor start to 2024.

Important employment data is on tap for the remainder of this week before the focus turns to inflation data next week. Is the dollar about to resume lower?

Why has the dollar eased?

In part, because of a small recovery in risk appetite with European markets and US futures bouncing back.

The dollar has also been undermined by the fact the FOMC’s meeting minutes that were released yesterday hardly contained any new information the market was already aware of.

While the ISM manufacturing PMI was more or less in line at 47.4, with activity in the sector remaining in contraction for yet another month (14 consecutive times).

Investors are also wary of the potential for this week’s other key US data to disappoint, or at least not beat expectations so significantly that they help to push back rate-cut expectations.

Meanwhile, we have also seen some improvement in foreign data, with Eurozone final PMIs being unexpectedly revised higher, a day after German and Spanish employment data topped expectations.

This has helped to underpin the euro and undermine the dollar index (EUR has the largest weighting on DXY at 57.6%).

On top of this, we had stronger-than-expected Caixin manufacturing (50.8) and services (52.9) PMIs from China, helping to ease concerns about the health of the world’s second-largest economy and biggest importer of many raw materials.

There’s little surprise then to see the likes of the Australian dollar outperform given the fact that the nation is the world’s top exporter of iron ore and one of the largest producers of copper.

With crude oil also bouncing back sharply on Wednesday, and extending those gains so far in today’s session, the likes of the Canadian dollar are also finding some support.

The dollar’s weakness comes after a strong start to the year as high expectations for a significant dovish shift by the Federal Reserve eased.

Investors have been a little more doubtful so far this week about whether the potential rate cuts will match the market’s high expectations.

The market anticipates up to 160 basis points in cuts this year, double the Fed's projection. Some investors feel that the market may be overestimating the rate cuts and was thus reversing their trades or taking profit on long-risk positions.

US employment data in focus before attention turns to inflation data

We will have some important market-moving employment data in these last two days of the week.

First up, the ADP private payrolls report and weekly jobless claims data, due for release later today, will shed some more light on the labor market, ahead of the official non-farm payrolls report on Friday.

As it is all about when the Fed will start cutting rates in 2024, the December jobs report could have significant implications on those expectations.

Last time, the jobs report was quite strong with both the headline jobs growing more than expected at nearly 200K and average hourly earnings printing 0.4% m/m.

If employment continues to remain strong, then the Fed may have to delay its rate cuts to prevent inflation from accelerating again. The market will be looking for evidence of a soft landing.

Looking further ahead, the economic calendar is a bit quieter next week, although we will have important inflation data at the of the week. US CPI will be released on Thursday, January 11, followed a day later by PPI, both at 13:30 GMT.

The market has priced in a rate cut for March with about a 75% probability, even though the Fed has suggested that the first-rate cut could come later in the year.

In December, the FOMC signaled 3 rate cuts in 2024, sending some of the US stock indexes to fresh record highs and causing a sharp drop in bond yields and the dollar.

Since that meeting, several Fed officials have tried to scale back market pricing of aggressive rate cuts, but this proved somewhat futile, even with US data remaining surprisingly resilient in some sectors of the economy.

The latest CPI data should have implications on rate cut expectations. Will inflation drop for the third month, from December’s 3.1% y/y print?

US Dollar Index: Technical View

The DXY’s recovery at the start of this year comes after it had dropped for two consecutive months at the end of last year. In that period, it only managed to rise in just two of the 9 weeks.

It was oversold. This means that the recovery so far in 2024 has been driven by profit-taking from oversold levels.

As such, it is reasonable to expect the recovery to fade near resistance levels. Indeed, the trend has been bearish and will remain that way until the charts tell us otherwise.

With that in mind, it is interesting to now see the DXY show some reaction to resistance around the 102.38 – 102.50 area.

Here, old support meets the resistance trend line of the bearish channel that has been in place since the end of October and start of November.

The 21-day exponential moving average comes in just below here, making it a key resistance zone.

How to trade the dollar

For as long as the 102.38 – 102.50 resistance area holds now, I would be looking to fade into any short-term bounces, with an eye on short-term support levels at 101.94 and then 101.21.

Liquidity below the December low at 103.32 would probably be an even bigger profit-target area for the dollar bears, as that level would come in just above the psychologically important 100.00 handle.

However, if the abovementioned 102.38 – 102.50 resistance area gives way, then we could see further follow-up technical buying towards the next resistance around the 103.21 – 103.45 area.

This is where the sell-off in December took place and where we have the 200-day moving average coming into play.

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Disclaimer: This article is written for informational purposes only; it does not constitute a solicitation, offer, advice, or recommendation to invest as such it is not intended to incentivize the purchase of assets in any way. I would like to remind you that any type of asset, is evaluated from multiple points of view and is highly risky and therefore, any investment decision and the associated risk remains with the investor.

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