Dollar forecast: Can rising oil prices revive the greenback after soft US inflation?

The latest US inflation report dealt the dollar a heavy blow, sending the greenback sharply lower as traders lowered expectations for a rate hike from the Fed. But despite the initial sell-off, this may not be the end of the bullish story. With crude oil prices climbing once again amid escalating geopolitical tensions, the dollar could yet find renewed support in the sessions ahead. I still hold a modestly bullish view on the US dollar forecast.

 

Oil prices could limit further dollar losses

 

The Dollar Index (DXY) suffered a sharp setback after headline CPI unexpectedly fell by 0.4% month-on-month, dragging annual inflation down to 3.5% from 4.2%. The softer-than-expected reading reinforced the view that inflationary pressures are easing more quickly than anticipated, weighing on US Treasury yields and the dollar.

 

While the inflation data has undoubtedly dented the dollar, the currency has shown notable resilience considering the run of softer US economic releases, including last week’s disappointing employment report. One explanation is the continued strength in energy markets.

 

Higher oil prices tend to support the US dollar by fuelling inflation concerns and reducing expectations for monetary easing. At the same time, elevated energy costs generally weigh more heavily on economies that are large energy importers, particularly across Europe, Japan and China.

 

If crude oil continues to climb, it may prove difficult for the dollar bears to justify holding onto their bearish bets, even with softer inflation (and employment) data.

 

Dollar Index (DXY) tests pivotal technical support

 

From a technical analysis standpoint, the picture remains far from decisively bearish for the dollar forecast.

 

The DXY is now starting to bounce back from significant support area between roughly 100.30 and 100.65, a region that previously acted as major resistance before eventually giving way during the mid-June rally. It is common for former resistance to become support, making this an important area to watch.

 

 

The dollar index has already bounced from this zone on more than one occasion. Whether buyers can defend it once again could determine the next major move. A successful defence, followed by a breakout above the current bull flag formation, would suggest the broader uptrend remains intact despite the recent weakness.

 

So, from a bullish point of view, watch out for a potential break above the 101.32 level – the high from Monday/Tuesday.

 

USD/CHF remains one of the stronger dollar pairs

 

Meanwhile, among the major currency pairs, the USD/CHF continues to stand out. Fundamentally, the pair also benefits from the wide interest rate differential between the United States and Switzerland. With Swiss interest rates remaining among the lowest in the developed world, the franc continues to struggle against a dollar that still offers a relatively attractive yield.

 

 

Anyway, the USD/CHF pair broke decisively above former resistance around the 0.8040 area in mid-June, confirming a bullish breakout. That level has since turned into support, while the rising 21-day exponential moving average is now converging around the same region, further reinforcing its technical significance.

 

Provided USD/CHF remains above this support, the path of least resistance continues to favour further gains.

 

Dollar forecast summary

 

Although weaker-than-expected inflation has interrupted the dollar’s recent advance, the broader outlook is not yet decisively bearish. The Dollar Index is sitting on an important technical support zone, USD/CHF continues to trade within a constructive uptrend, and rising crude prices could provide the fundamental catalyst needed for another leg higher.

 

As long as energy markets remain firm and geopolitical risks stay elevated, the dollar may prove more resilient than the latest inflation report initially suggests.

 

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R