The week that was
A dreadful week for the US Dollar (USD) saw the US Dollar Index (DXY) recede to the area of multi-week troughs near 98.50, an area also coincident with its critical 200-day Simple Moving Average (SMA).
The selling pressure on the Greenback has been driven exclusively by cooling tensions in the Middle East, which have been particularly exacerbated following the two-week ceasefire deal between the US and Iran clinched late Tuesday.
Despite uncertainty appearing to have dissipated somewhat, some issues still linger regarding the agreement, such as the inclusion of Lebanon in the ceasefire deal and the reopening of the Strait of Hormuz, a vital path for the shipping of crude oil.
The strong retracement in the Greenback has broadly tracked an equally decent pullback in US Treasury yields, particularly in the short end and the belly of the curve, all reflecting the back-and-forth nature of headlines surrounding the geopolitical situation.
Fed officials: policy in a good place, but risks pulling in both directions
A fresh batch of Federal Reserve (Fed) speakers reinforces the idea that policy is already restrictive enough, but the outlook is becoming increasingly complicated as energy shocks and geopolitics blur the path ahead.
Officials across the board expressed confidence in maintaining current rates while remaining open to adjustments based on the evolution of inflation and growth.
Mary Daly (San Francisco) signalled that the Fed still has flexibility, but the next move will depend heavily on how the oil shock evolves. If tensions ease and oil prices fall back, rate cuts remain on the table. If inflation stays sticky, the Fed is ready to hold for longer.
She made it clear that the inflation job was not done even before the latest shock, and higher energy prices will only delay progress. At the same time, she acknowledged the trade-off, as rising costs were already starting to weigh on consumer behaviour.
Philip Jefferson (Board of Governors) also leant toward that cautious stance, highlighting high uncertainty and risks on both sides of the Fed’s mandate. The labour market increasingly faces downside risks, while inflation remains above target. His comments suggest that policy remains well positioned and rates close to neutral.
Austan Goolsbee (Chicago) was more blunt, describing higher oil prices as a stagflationary shock. He warned that the Fed is operating without a clear playbook, with inflation risks still present and a growing risk that they will become entrenched. He also pointed to a labour market that was stable but not particularly strong.
John Williams (New York) struck a more constructive tone. He expects headline inflation to rise due to the conflict but sees the core trend still moderating. He added that policy is well positioned to wait, with the economy holding up, although the labour market is becoming more complex and less dynamic.
The takeaway:
- Policy seen as appropriately restrictive / near neutral
- Cuts possible, but conditional on inflation easing
- Inflation risks still elevated, especially via oil
- Growth risks rising, particularly via demand slowdown
So, the Federal Reserve is comfortable where it is, but the world around it is getting more complicated. Policy appears to be in a good place, but the path forward depends heavily on oil, geopolitics, and how inflation feeds through, and with the reaction function now clearly two-sided, conviction on the next move remains low.
The Minutes from the March 17-18 meeting seem to have reinforced that view. They showed that the Fed is still in wait-and-see mode, but officials are starting to realise that the risks are becoming more balanced.
Furthermore, most policymakers felt that keeping rates the same was the proper thing to do, and virtually all supported not changing them in March. At the same time, many members thought that policy was already in a reasonable range of neutral, which means that the bar for additional tightening is still rather high.
Inflation remains elevated
As mostly expected (feared?), inflation in March posted a decent uptick, with the Headline Consumer Price Index (CPI) gaining 3.3% from a year earlier, up from February’s 2.4% annual gain. The core print, which excludes more volatile items like food and energy costs, also edged higher, albeit at a more modest pace: 2.6% from 2.5%.
It does appear that the disinflationary process that was in place in the last few months has been interrupted by the geopolitical factor, namely the spike in prices of the barrel of crude oil. That said, this decent uptick in inflation should be temporary, or at least that is what everybody is hoping for.
This week, we also saw the release of the Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) index, which held steady at 2.8% over the year to February while easing to 3% over the last twelve months (from 3.1%) for the core gauge.
It is expected that the inflationary landscape will turn worse before getting any better, as market participants now need to factor in the impact of the still-closed Strait of Hormuz along with the effects of US tariffs.
Now, about the other half of the mandate…
The latest report of the US labour market showed the economy added 178K jobs in March, crushing initial estimates and making for quite the reversal from February’s revised 133K drop, according to the Bureau of Labor Statistics (BLS).
In addition, the Unemployment Rate ticked lower to 4.3%, while the Average Hourly Earnings, a proxy for wage inflation, rose 3.5% from a year earlier, although it receded from the previous month’s 3.8% reading.
USD positioning: steady longs, conviction gradually improving
The US Dollar speculative positioning story remains one of a gradual rebuild rather than an aggressive shift. After flipping from a small net short to a modest net long earlier in the month, positioning has stabilised, holding around 3.6K–3.7K contracts recently, according to the Commodity Futures Trading Commission (CFTC).
While the headline positioning move may appear modest, the underlying dynamics are more constructive. The Greenback has continued to strengthen in price terms, with the index moving higher toward the 99.80 area, and open interest has risen notably to fresh highs for this cycle. This combination indicates the addition of new longs rather than relying solely on short covering.
This is consistent with a market that is slowly rebuilding USD exposure, propped up by firm US yields and lingering geopolitical uncertainty, but without yet reaching crowded territory.
The implication is that the Dollar still has room to run from a positioning perspective. Given that the current trend hasn’t yet reached its peak, it could continue without the immediate risk of traders getting exhausted. This also supports the idea that the US Dollar’s value might keep going down, especially if the overall economic situation stays stable.
What’s next for the US Dollar
Next week, US inflation is expected to remain at the centre of the debate on the US calendar, with the release of the Producer Price Index (PPI) on Tuesday. In addition, the usual weekly report on the US labour market should also be closely watched.
In addition, comments from Fed officials are also expected to keep investors entertained.
Bottom line
The recent loss of traction of the US Dollar appears logical – and maybe expected – in light of the safe-haven-led surge that took place in response to the US and Israeli attacks on Iran in late February.
Returning to the pre-conflict scenario, tariffs were in centre stage, with market participants increasingly worried about elevated consumer prices. Indeed, inflation remains uncomfortably high… and the labour market is cooling at a slower pace than desired.
In that scenario, the Fed would likely double down on patience, maintaining a steady stance that could, over time, offer fresh support to the US Dollar.
Inflation FAQs
Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.
Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.
Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it.
Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.
