US dollar to remain under heavy selling pressure

Softening inflation and the labour market will continue to pile pressure on the greenback

The US Dollar Index dropped below the key 100 level in July. Reuters

The weakness in the US dollar has continued through to the start of the third quarter, with improving US economic data – dominated by cooling inflation – hitting forecasts hard for the greenback.

At the time of writing, the US Dollar Index, a measure of the value of the dollar against a weighted basket of major currencies, was trading below 100, down by about 3 per cent in July.

Since we last spoke, inflation fears continue to retreat; the most recent Consumer Price Index and Producer Price Index reports showed that price pressures came in at 3 per cent and 0.1 per cent year on year, respectively (versus 4 per cent and 0.9 per cent previously).

Watch: US Federal Reserve raises interest rates for 10th consecutive time

The most recent payrolls report released on July 7 showed that only 209,000 jobs were added in June, well below the expected 225,000 jobs.

So much of the US Federal Reserve's expectations regarding future rates has been dictated by inflation and employment and with July’s data showing continued signs of cooling on both fronts, we are now in a situation where we find the US dollar under heavy selling pressure.

Whether this proves to be premature remains to be seen.

One thing we know for sure is that come the next Fed meeting, which concludes on July 26, we will have another interest rate increase, taking the overall rate to 5.5 per cent.

According to the CME Group’s FedWatch Tool, markets are already pricing this in with a 96 per cent certainty.

The easing inflation threat and cooling US jobs market then begs the question: Other than July, will the Fed look at one or two more rate increases in 2023?

Or could we be in situation whereby we will not have another rate increase in 2023 following July’s action?

Looking ahead and using the same CME tool, markets are pricing in an 83 per cent chance of a hold during the September meeting, a 67 per cent hold in November and a 58 per cent chance that rates will end the year at 5.5 per cent in December.

It will be interesting to see how these values change over the course of the next few weeks and months – and will be entirely reliant on the coming US data.

Softening inflation and the labour market will continue to put pressure on the US dollar. As a result, there will be more upside for major currencies against the greenback and also upwards momentum in US stocks.

With so much of the fundamental picture dependent on data, technicals may provide a bit of clarity when it comes to how low the US Dollar Index could fall.

Following the psychological break of the 100 level, near-term support in the index kicks in at 99.30 levels – and a break of this could expose a level of 96.30 before we begin the fourth quarter.

Keep an eye on the US jobless claims on Thursday, which shows how many people file for unemployment benefits every week in the US.

Any falling number will lead to dollar weakness in the short term and vice versa.

This will precede the July Fed meeting, which concludes on Wednesday night, with the decision due out at 10pm Dubai time.

Pay attention to forward guidance from the Fed. While recent speakers have continued to allude to the inflation threat, this message could be repeated.

However, I do believe markets will shrug it off and continue piling into higher-yielding assets, which will keep the dollar under pressure.

Meanwhile, earnings season is in full flow and will, no doubt, be critical to future guidance of equity pricing.

On Wednesday, Tesla, Netflix and IBM will announce their results after market close.

Microsoft and Google owner Alphabet will announce their results next Tuesday, followed by Meta on July 26 and Amazon on July 27.

Again, it is important to note that markets have already priced in a weaker earnings season.

Earnings are expected to drop by more than 7 per cent to their lowest since 2020, so it is best to focus on companies' comments on their views of forward guidance.