The Dollar extends its recovery to a maximum of two and a half months before the vote on the debt limit

• The dollar regained its strength mid-week amid risk aversion.
• The Dollar Index reached its highest level in more than two months above 104.50 on Wednesday.
• The US debt ceiling bill has advanced to the House of Representatives for debate and a vote.

In the middle of the week, the US dollar started to strengthen against its main rivals, amid a negative change in risk perception, after the lackluster performance on Tuesday. The Dollar Index, which tracks the dollar’s valuation against a basket of six major currencies, turned north early on Wednesday and hit its highest level since mid-March at 104.63.

Dollar developments are likely to continue to be affected by risk perception in the second half of the day, with investors watching headlines around the debt limit bill.

On Tuesday, the House Rules Committee approved the debt limit bill by a close 7-6 vote, prompting investors to take a cautious stance. Several Republican legislators expressed their opposition to the bill, which will be debated in the full House and voted on Wednesday before going to the final vote in the Senate.

Daily Market Drivers Recap: Dollar Gains Ground on Wednesday

• Reflecting the risk aversion prevailing in the markets, US stock index futures are trading in negative territory.
• In an interview with the Financial Times, Cleveland Federal Reserve (Fed) President Loretta Mester said she doesn’t necessarily see a compelling reason to pause rate hikes amid “really entrenched inflationary pressure.” and stubborn.”
• The 10-year US Treasury yield continues to push lower and was last seen shedding more than 1% on a daily basis below 3.7%. However, CME Group’s FedWatch tool shows that markets are pricing the probability that the Fed will raise its policy rate by 25 basis points (bps) in June at almost 70%.
• On Wednesday, the US Bureau of Labor Statistics will release JOLTS data for job openings for April. On Thursday, the ADP report on private sector employment and the ISM manufacturing PMI survey will be on the US economic agenda.
• According to Yohay Elam, an analyst at FXStreet, “ADP’s figures have not only jumped from ‘disappointing’ to ‘surprising’ and vice versa, but these differences have also been significant, especially in recent months.” “After jumping to the highest level since July 2022 in the last April release, the next May report could be weak.”
• US consumer sentiment weakened slightly in May, with the Conference Board (CB) Consumer Confidence Index dipping to 102.3 from 103.7 in April (revised from 101.3). The current situation index fell from 151.8 to 148.6, and the consumer expectations index was virtually unchanged at 71.5 points. Finally, one-year inflation expectations fell to 6.1% in May, compared to 6.2% in April.
• House prices in the US increased 0.6% on a monthly basis in March. This reading followed February’s 0.7% rise (revised from 0.5%) and beat market expectations of +0.2%.
• On Sunday, the President of the United States, Joe Biden, and the Republican Speaker of the House of Representatives, Kevin McCarthy, reached an agreement to temporarily suspend the debt limit and thus avoid a default on US debt. The House of Representatives and the Senate must still approve the agreement in the coming days, which will suspend the maximum debt limit of 31.4 trillion dollars until January 1, 2025.
• The US Bureau of Economic Analysis (BEA) reported on Friday that inflation in the US, measured by the change in the Personal Consumption Price Index (PCE), rose to 4.4% annually in April, from 4.2% in March.
• The core PCE price index, the Fed’s preferred inflation gauge, rose to 4.7%, versus 4.6% expected by the market.
• Other details from the BEA release showed that personal income rose 0.4% per month, while personal spending rose 0.8%.

Technical Analysis: US Dollar Index Turns Bullish After Tuesday’s Drop

The US Dollar Index (DXY) managed to close above the key technical level of 104.00 (23.6% Fibonacci retracement of the November-February downtrend) on Tuesday, reflecting buyers’ willingness to defend that support. In case the DXY starts to use 104.50 (static level) as support, it could target 105.00 (psychological level, static level) and 105.60 (200-day SMA, 38.2% fibonacci retracement) below.

down, 104.00 remains intact as key support. A daily close below that level could attract USD sellers and open the door for a longer slide towards 103.00, where the 100-day SMA sits.

Also worth noting is that the Relative Strength Index (RSI) on the daily chart is holding close to 70, suggesting that the DXY could correct lower in the short term before the next leg higher.

How Does Fed Policy Affect the Dollar?

The US Federal Reserve (Fed) has two mandates: maximum employment and price stability. The Fed uses interest rates as its primary tool to achieve its goals, but it has to find the right balance. If the Fed is concerned about inflation, it tightens policy by raising interest rates to increase the cost of borrowing and encourage saving. In that scenario, the US dollar (USD) is likely to gain value due to the decline in the money supply. On the other hand, the Fed could decide to ease policy through rate cuts if it is concerned about a rise in the unemployment rate due to a slowdown in economic activity. Lower interest rates are likely to spur investment growth and allow companies to hire more staff. In that case, the dollar is expected to lose value.

The Fed also uses quantitative tightening (QT) or quantitative easing (QE) to adjust the size of its balance sheet and steer the economy in the desired direction. QE refers to the Fed buying assets, such as government bonds, on the open market to stimulate growth, while QT is the exact opposite. In general, QE is seen as a dollar-negative central bank policy move, and vice versa.