US Dollar, USD/JPY Hold Firm Ahead of FOMC

The US dollar shrugged off crude oil's sharp decline following reports of renewed US-Iran negotiations, highlighting underlying demand for the greenback ahead of this week's FOMC meeting. With markets pricing a growing chance of further Fed tightening, attention now turns to Chair Kevin Warsh's guidance and whether DXY and USD/JPY can extend their bullish trends.

 

 

Source: LSEG

 

 

US Dollar and USD/JPY Stay Supported Ahead of the FOMC Meeting

Crude oil prices plunged -11.3% on Monday after the US announced it had paused its attacks on Iran, allowing room for negotiations. While President Trump has threatened strong military Iran if talks fail, markets are once again looking at it optimistically. However, it is interesting to note that the pullback on the US dollar was minimal at best, falling as little as 0.25% from the week’s open before scraping a 23-high by the day’s close.

While the Fed is expected to hold interest rates steady at this week's FOMC meeting, markets will pay close attention to Chair Kevin Warsh's comments regarding the latest flare-up in Middle East tensions. While the US and Iran are reportedly in talks and attacks have stalled, this is far from the first time. It also seems highly unlikely that any meaningful agreement will be reached, let alone signed, before the Fed meeting.

That leaves the risk of renewed inflationary pressures intact, along with credible concerns that the Fed could resume hiking interest rates if inflation proves persistent. The US dollar therefore has scope to remain supported heading into this week's interest rate decision, with post-meeting moves likely to be dictated by the perceived hawkishness of Warsh's press conference. We could also see dissenting votes in favour of a rate hike, which would likely add to any bullish reaction in the US dollar.

Fed funds futures currently imply a 55% chance of a hike in September and a 39% chance of another in December. Whether the US dollar extends its lead will likely hinge on whether Warsh validates those expectations.

 

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US Dollar Index (DXY) Technical Analysis

Last week’s bullish expansion rallied from the 10-week EMA and monthly pivot point. This hints that the prior week’s spinning top Doji – which also respected the 10-week EMA as support – could mark an important swing low above the 100 handle. 102 looks within relatively easy reach for bulls unless the Fed surprise with a neutral stance and the US and Iran finally sign a peace deal. I am not holding my breath.

But with the weekly RSI (2) trending higher with prices and nowhere near oversold, a break above 102 could also be on the cards in the coming weeks, if Middle East tensions persist and keep inflation expectations elevated.

 

 

 

Bullish initiation Near Cycle Highs

Also note that a bullish engulfing candle formed on Monday, with its lower wick hinting at demand around 101. Prices remains above the monthly VWAP, with a break above 101.50 assuming a move to the 12 handle near the monthly R1 pivot.

Something to be mindful of is that volumes are trending lower on the weekly and daily chart. This does not suggest an imminent top, but suggests the bullish move still has its sceptics. That said, Monday’s bullish outside day saw increased volume relative to Friday and Thursday’s range expansion candle was relatively high volume and above average to show bullish initiation just below the cycle high.

Source: ICE, TradingView

 

 

The US Dollar's Strongest Market Correlations

• EUR/USD, GBP/USD and NZD/USD remain the strongest inverse correlations to the US dollar, reinforcing their sensitivity to broad USD moves.
• USD/JPY, USD/CHF and USD/SEK continue to show strong positive correlations, making them reliable proxies for USD strength.
• WTI crude has re-established a strong positive correlation with the US dollar, while gold's inverse relationship has weakened significantly over the past month.
• AUD/USD remains the outlier, with correlations close to neutral, suggesting domestic factors and China-related themes are outweighing broad USD flows.

Source: LSEG

 

 

USD/JPY Technical Analysis: US Dollar vs Japanese Yen

The bullish trend on USD/JPY remains firm, and only held back by market participants who seem wary of another intervention from the MOF. Though the MOF appear to have thrown the towel in for now, conceding that they’re currently swimming against the tide of potential Fed hikes, Middle East headlines and inflationary pressures. And that could leave USD/JPY with the potential for a breakout above 164.

Traders may also want to be wary of the bearish divergence on the daily RSI within the overbought zone, but that doesn’t mean it cannot at least try for a breakout over the near term given the bullish pinbar on the daily and potential bull flag on the 4-hour chart.

Note that Monday’s low respected the weekly pivot point and the weekly R1 sits just below 164.50, a potential upside target for bulls.

Source: ICE, TradingView

 

 

 

 

-- Written by Matt Simpson

Follow Matt on Twitter @cLeverEdge